Assured Guaranty Ltd (AGO) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2006 Assured Guaranty's earnings conference call. My name is Nicole, and I will be you coordinator for today. At this time, I all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [OPERATOR INSTRUCTIONS] I would now like to turn your call over to Ms. Sabra Purtill, Managing Director, Investor Relations and Strategic Planning.

Thank you, Nicole, and thank you all for joining us for Assured Guaranty's third quarter 2006 earnings conference call today. We released our earnings press release and financial supplement yesterday evening and these materials, as well as other information on Assured Guaranty, are available on our website at www.assuredguaranty.com.

Our speakers today will be Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Limited; and Bob Mills, Chief Financial Officer. After their remarks, the operator will poll the audience for questions.

Before turning the call over to Dominic, I would like to remind you all that our commentary today may contain forward-looking statements, such as statements relating to our financial outlook, business strategy, growth prospects, ratings, goals, personnel demands, and other market conditions.

Actual results may differ materially. In addition, for those of you listening to the webcast or replay of this call, please be advised that more recent information may be available on Assured Guaranty. Please refer to our most recent SEC filings, as well as our earnings press release and financial supplements for more information on factors that could affect our forward-looking statements.

With that, I would now like to introduce Dominic Frederico.

Thank you, Sabra, and thanks to all of you on the call, webcast, for your interest in Assured Guaranty. The third quarter was another strong quarter. Our exceptional production results are further evidence of our sustained ability to increase our market share and expand our direct franchise. Our total production was more than double last year's quarter, and both our direct and reinsurance financial guarantee segments posted significant growth over the prior year.

Our new business production of $338 million for the first nine months is a Company record and even exceeds the $290 million that we wrote for the full year of 2004, previously the best year in the Company's 19-year history. Our strategy and approach to the market does not change. We target markets where we believe Assured Guaranty has competitive opportunities based on our dedicated resources, and our commitment to service and timely transaction execution.

This resulted in our second highest direct new business production after the record production of last quarter. While there were a handful of large deals in the quarter, production was still up 50% over the prior year's quarter excluding deals that had PVP in excess of $5 million, further confirming the expansion of our direct franchise and our ability to achieve greater market share.

In the third quarter, our reinsurance segment, again, similar to last quarter, benefited from large transaction activity, particularly in international, which has been a very active segment this quarter.

Our direct pipeline remains strong, significantly above the prior year, and at about the same level as the last two quarters, despite market conditions that have challenged many of our competitors' ability to grow new business production. Our reinsurance pipeline is also robust. These results in both of our segments are consistent with what we have identified as two of Assured Guaranty's market opportunities.

In direct business, fixed income investors that need greater diversification among financial guarantors, and for reinsurance the primary financial guarantee companies need to manage their capital and risk accumulation. These two core needs will continue to help drive our growth.

We remain focused on building our new business pipeline by matching our underwriting focus and service commitment to those investors and guarantors that fit this model.

While business production results for both direct and reinsurance may fluctuate from quarter-to-quarter because of large deals, our ability to identify and capitalize on these needs in a manner consistent with our underwriting standards and return hurdles is a key component to creating long-term shareholder value.

In addition to our new business accomplishments, I'm equally pleased that we achieved our market share and new business production gains without sacrificing our credit standards. We have continuously maintained an average insured portfolio credit quality of AA minus while growing our net par outstanding by 19% since December 2005.

During the most recent quarter, 84% of our direct financial guarantee new business par written was AAA rated. Today, 40% of our overall in force portfolio is now rated AAA even including the reinsureds operations as of the quarter's end. Our ability to maintain credit quality, particularly given tight credit spreads, is evidence of our success in finding market niches that are profitable for us given our split rating, but that meet our underwriting and return standard.

While we still face many challenges, particularly our ratings differential and the overall market environment, we are clearly achieving our objectives in the marketplace. Our market share remains well above the 5% threshold established by Moody's for consideration of a AAA rating, and we meet the financial test for that rating level, as well. In addition, we continue to expand our underwriting asset classes, and to attract and retain top-notch professionals.

In summary, we believe that we are well positioned in the market for the fourth quarter and into 2007. Our emphasis on service and execution will provide us with opportunities in those markets that value our underwriting expertise and efficient execution capability. We are committed to building a leading financial guarantee company and to achieving our strategic objective of creating long-term shareholder value. Now I'll turn the call over to Bob Mills who will discuss our financial results.

Thanks, Dominic, and good morning. Before I begin, I would 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.

Last quarter, I began providing direct market share information based on percentage of par written as part of my quarterly commentary. At that time, I noted our market share for the fourth quarter of 2005 was 5.5% and our market share for the first quarter of 2006 was 5.6%. Since not everyone had reported results at that time, I also estimated that our market share for the second quarter 2006 would be in excess of 8%. I'm now able to report that the actual market share for the second quarter 2006, was 8.8%.

For the third quarter 2006, again, because not everyone has yet report reported results, I'm only able to estimate the amount. I believe our market share will be in excess of 7% for the third quarter. Based on these results, this is our fourth consecutive quarter exceeding the 5% guidepost threshold established by Moody's moving toward the final upgrade to AAA.

Moving on to results, net income for the third quarter of 2006 was $37.9 million, or $0.51 per diluted share, compared to $39.2 million, or $0.53 per diluted share for the third quarter of 2005. Our operating income per diluted share, which we calculate as net income excluding after-tax realized gains and losses on investments and after-tax unrealized gains and losses on derivative financial instruments, is $39 million, or $0.53 per diluted share compared to $38.9 million, or $0.52 per diluted share for the third quarter of 2005.

During both the third quarters of 2006 and 2005, operating income included $0.01 per diluted share in the other segment.

Let's look at the details in a bit further detail. PVP, or present value of gross written premiums, totaled $127.4 million for the quarter compared to $61.9 million for the third quarter of 2005. PVP for the direct segment totaled $90.9 million, an increase of 131% from the third quarter 2005 amount of $39.4 million. Production in the direct segment included strong performance across all sectors of the business.

During the current quarter, we again had a large number of direct transactions, as Dominic mentioned. There were five transactions closed during the quarter with PVP in excess of $5 million. PVP for the reinsurance segment totaled $36.5 million, an increase of 62% from the third quarter 2005 amount of $22.5 million. Treaty sessions and facultative business were both quite strong during the quarter.

The performance was influenced by the fact that the quarter included seven large transactions with PVP in excess of $1 million. Excluding large transactions, PVP increased by 2%, comparing the third quarter of 2006 versus 2005. There will be volatility of the PVP in this segment as the volume of large transactions fluctuates period to period. Also included in treaty sessions this quarter because of the one quarter lag in reporting is PVP of $9.5 million from the Ambac treaty relationship that expired as of June 30 and was not renewed.

Net earned premium for the quarter totaled $51.9 million, down 5% from the third quarter 2005 amount of $54.5 million. For the financial guarantee direct segment net earned premiums totaled $21.8 million for the quarter, compared to $18.3 million in the third quarter of 2005, an increase of 19% in the current quarter, which is reflective of our continued expansion in that market.

Net earned premiums for the reinsurance segment were $25.4 million, a decrease of 21% from the third quarter 2005 amount of $32 million. This amount is in line with our expectations.

Looking to the fourth quarter and 2007, reinsurance earned premiums should remain relatively unchanged without giving consideration to the level of refundings. Net earned premiums for the mortgage segment were $9.4 million, up 14% compared to the third quarter 2005 amount of $4.3 million. The increase reflects a $900,000 commutation completed during the quarter. Absent this commutation the results reflect the continued runoff of the quota share book of business while no new business was written in the quarter.

Loss and loss adjustment expenses incurred totaled $0.9 million for the quarter compared to a $0.8 million benefit for the third quarter of 2005. During the third quarter of 2006, there were net case losses and loss adjustment expense recoveries of $1.4 million, and a net portfolio reserve expense of $3.3 million. There was also an additional recovery of $1 million in the other segment.

This net result coincides with my previous statement that for the balance of 2006, I expect loss and loss adjustments to result in a net expense as new business expands. Notwithstanding loss and loss adjustment expenses are subject to volatility based on production and credit losses.

Looking strictly at case losses and lost adjustment expenses for the third quarter, the major items that comprise this net amount are $2.4 million in recoveries in the reinsurance segment and $0.3 million in recoveries in the direct segment, offset by case reserve movement of $1.3 million on a number of credits in the reinsurance segment.

The net increase in portfolio reserves was the result of a number of factors, including new business, the runoff of old business, normal credit migration, the update of rating agency frequency and severity factors, and further development related to a European infrastructure transaction previously included in our closely monitored credits listing.

The investment portfolio increased $130 million from the balance as of December 31, 2005. Cash and cash equivalents have also increased by $9.5 million. Yields increased 30 basis points, comparing the third quarters of 2006 and 2005 for the pre-tax book yield of 5.1% at the end of the current quarter, while the duration remained relatively flat at four years. There has been no significant change in the investment portfolio during the quarter and the average credit quality for the portfolio remains at the AAA level.

During the quarter, the market value of our investment portfolio increased by $38 million net of tax as the result of a more favorable market environment. Since this portfolio's long-term investment in nature, changes in value are reflected in the accumulated other comprehensive income account.

Other operating expenses increased by $1.5 million, or 10%, in the third quarter of 2006, compared with the third quarter of 2005. This increase was attributable to the adoption of FAS Statement 123R for share-based payments in 2006, and the additional amortization of restricted stock awards. The level of expenses in the third quarter overall continues to be in line with expectations.

Our book value per share was $24.02, increased from $21.81 book value per share at the end of the third quarter of 2005. Adjusted book value, which adds the embedded value from after-tax net present value of estimated future installment premiums in force and after-tax net unearned premium reserves that of DAC was $34.43 per share at quarter end, an increase of 16% from $29.62 per share at the end of the third quarter of 2005.

The Company's operating ROE in the third quarter, which is calculated by dividing our annualized quarterly operating income by average shareholder's equity, excluding accumulated other comprehensive income was 9.2%. With that, I'd like to turn the call over to the operator to poll for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Mark Lane with William Blair and Company. Please proceed.

Good morning, everyone.

Good morning, Mark.

Few questions, first of all a number question, regarding the number of transactions in the quarter, including the number of public finance deals?

The-- yes, hi, Mark. The number of transactions in the quarter was 44, of which in the public finance area we did 15.

Okay. And Bob, just to-- so I make-- make sure I heard you correctly, on the reinsurance side, what you are saying is that you would expect scheduled net-earned premium to be relatively stable in the fourth quarter and stable in '07 relative to '06?

That's-- that's exactly right.

Okay. And then--

For reinsurance.

Right for reinsurance.

Certainly direct we'll have some considerable growth.

Right. And then the last question is can you give us a little bit more detail on the impact from-- on the loss ratio from updating the rating agency loss factors? I didn't really under-- don't get that.

It's not a huge impact. The impact on the quarter, the update of the frequency reserves was just about $1 million.

Okay. Okay. Great, thank you.

Thank you, Mark.

And your next question comes from the line of Tamara Kravec with Banc of America. Please proceed.

Thank you, good morning. If you could go into more detail on some of the structured finance transactions you're seeing. Obviously, the volume has been fairly high in the second and third quarters relative to prior quarters, and whether you would expect that to be lumpy going forward, or just a little color on that would be great? Thanks.

This was a very unique quarter for us, in that not only did we achieve a very high level of production through the PVP, as I said, the other interesting statistic is that 84% of it was rated AAA.

If you break it down by asset class, obviously, it has been a very strong market year for the whole structured finance area, and this quarter had a very significant component of CDO's CLO's and trust preferreds. However, in the quarter we also had a very active ABS market as we did some commercial asset structure, some equipment leasing, some rolling stock that really also added significant value to the portfolio in terms of PVP and par written. We also did our first student loan transaction in the Company, as well as a [INAUDIBLE] deal. So it was a really strong mix. We still had some great international activity, both in the structured credit, be that the CLO, CDO market, as well as further UK regulated utilities and some asset-backed securitization.

Okay. Great. Thanks.

Next question?

And your next question comes from the line of Mike Grasher with Piper Jaffray. Please proceed.

Good morning.

Good morning, Mike.

Couple of questions. I think you mentioned the reinsurance pipeline being robust. Can you talk a little bit more about that? I'm assuming that's mostly facultative arrangements that you are seeing or potentially could be seeing?

Yes, Mike, thanks, as you know we have constantly been switching to a greater FAC component of the total deals done, both in the PVP and written premium base, we're up to about 28% in the quarter which is over the prior year. So when we talk about pipeline of the reinsurance, obviously, we can't really speculate what will come through the trees and we, obviously, have our ear to the track in terms of hearing what's being done in the market, so we try to get an idea.

But mostly we refer to there is the FAC pipeline where we, obviously, monitor all of the submissions and go over kind of an open-deal flow as we look, you know to the next quarter. And this quarter has atypically some larger deals in it than what we have been seeing in the past, and pretty much driven from the international marketplace which, I said, was a very strong quarter and seems to be a very active market this year for all of the monolines.

Also, I think you've done a magnificent job extending the asset classes. Are there any asset classes out there yet you feel like you need to get involved in?

Well, nothing that we can get involved in, you know, based on our current split rating. Obviously, we're still extremely deficient in public finance, in the large GO, you know, higher-rated structures or transactions there, and we're still very much out of the flow ABS market. So-- but other than that I think we have done through our direct operation, a fairly significant job in making penetration in those areas, or as I said, where we think we have a competitive opportunity, and, you know, using our relationships, timely execution and the commitment resources to get those deals done.

And maybe just update us as a follow-up on the trading differentials right now?

The trading differentials, as I think we talked a little bit about last quarter, with the announcements of the positive outlook from Moody's we did see some tightening in the public finance area for fixed-rate offerings. We had come into about a 12 to 15 range from previously at a 15 to 20 range. We had similar tightening, but, obviously, to a lot lesser extent in the other asset classes, and we just think that's going to be a continuing story.

You know, most of the deals done in the quarter were deals that were in the pipeline and the Moody's announcement came out very late last quarter, so we're still looking for more the benefit of that as we look forward to fourth quarter of '06 and, obviously, looking into '07.

Okay. And then just a couple of questions for Bob real quick, I guess, first of all thanks for providing the market share information, and, secondly, did you mention what the new money invested-- or invested-- excuse me-- new money rate is for the investment portfolio?

I didn't mention those, but I will now.

Thank you.

For taxable investments, the new money yield is 5.3%, and tax exempt that's 4%. Cash is sitting about 5.1, right about where we are at the moment, so that's really our-- my estimate of the new money yields at the moment.

Okay, I'm sorry, the tax exempt again was how much?

4.0.

Thanks very much, congratulations on the quarter.

Thank you..

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Darin Arita with Deutsche Bank. Please proceed.

Hi, good morning.

Good morning.

I'm taking a look at the direct segment and the unearned premium reserves and installment premiums in force have increased quite a bit over the past couple of quarters, and was just wondering if you could give us a sense of how fast those reserves or installments should amortize into revenues versus the book before the increase?

Yeah, you know, it's-- it's-- it's a good question. You know, we look at earned premium, and we're obviously committed to providing an earned premium rollout by the end of the year, to give you a better color on this, but if you understand our direct book-to-business, historically, it was written a swap transaction basis which sort of dated transactions, as we then switched to an absolute concentration in the monoline market for direct business. That brought in, obviously, the public finance, [INAUDIBLE] but also real financial guarantee transactions as opposed to swaps, so we're actually experiencing this shift of the typical earning rate of the premium by transitioning the historical book on the direct side to the, you know, current book we have been writing for say the last 1.5 to 2 years, so our tenure is going to be that typical of the rest of the industry, and it really goes transaction by transaction.

The international utilities are extremely long dated so those are nice PVP, nice par. They will take a very long time to contribute significant earnings. And we have just got to build up, you know, quarter after quarter the type of transaction volume we're seeing say for the last two quarters before we're going to really have meaningful movements in earned premium.

Okay. And so I get the sense that over the last two quarters there-- the increases more related to longer dated transactions?

Yes. Over the typical average age in the portfolio is lengthening, but as you see in the current quarter we're up about 19%, we expect that percentage to increase because of the amount of new business that has been put on the books in the last three quarters, and we're going to have a year this year, obviously, that's well in excess of any year we have ever done and that will have a significant contribution to continue that increasing, you know, rate in the earned premium for the direct side.

We do intend for the fourth quarter supplement to include a earned premium rollout for you, so that will make it a little easier for you to see.

Great. That would be helpful. And then, I guess, touching more on the international deals in the quarter, can you give us a sense of what sort of deals you saw?

The international deals kind of run the gamut. We had some CLO of PFI loans. We had a prime residential mortgage deal.

We had a commercial mortgage-backed deal. We had two of the UK utilities. We did about four CDO's, a commercial ABS, and a secondary PFI synthetic that was previously wrapped by another guarantor. So a really good mix of business coming out of the international. The international has been a tremendous success story based on new management out there that we put in at the end of last year, and just a real dedication of focus to the market by the folks out there.

Okay. Great. Thanks very much.

Thank you.

And your next question comes from the line of James Shanahan with Wachovia Securities. Please proceed.

Thank you, and good morning.

Good morning.

I'm looking at your disclosures here on the website and you're saying now $190 million of hurricane-related exposure at September 30. That's down about $4 million from three months ago, but down $30 million from a year ago? Has AGO actually had any hurricane-related losses, and what is the outlook for hurricane-related losses given the remaining exposure?

I think as we mentioned in previous calls, we paid a small loss, probably back a couple of quarters, it was immediately reimbursed. So we had no net losses paid on the hurricane exposures and, obviously, at this point in time it continues an improving story, so we're really not anticipating any further loss activity.

Okay. And what were the total number of employees at September 30, and in what areas did the Company add or lose professional or executive level census during the period?

The total number of employees at September 30, was 131.

Okay.

The-- and we-- we have added some employees since that point in time, and are basically associated with support for the business expansion. We have added support and surveillance and credit, as well as, you know, front-line people to support the business. There have been no losses of personnel during the quarter.

Thank you. One more quick one, is the exposure to CDOs still substantially AA rated or better? .

It's substantially AAA rated or better.

It's 94%, I believe the number is.

90% is AAA rated.

I'm sorry, 90% AAA and a total of 99% is AA or better?

Yes, I would say that's a fair characterization.

Thank you very much.

You're welcome, thank you.

There are no further questions at this time I would now like to turn the call back over to Ms. Sabra Purtill.

Thank you, Nicole. And many thanks to you all for joining us today. We certainly appreciate your interest in Assured Guaranty. A replay of this call will be available on our website, as well as our telephone at 888-286-8010 for U.S. callers, and at 617-801-6888 for international callers. The pass code is 74314028, and of course a replay will also be available on our website at www.assuredguaranty.com. If you have any additional questions or information needs, please feel free to contact me. Thanks again and have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.