Assured Guaranty Ltd (AGO) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Assured Guaranty earnings conference call. I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Miss Sabra Purtill, Managing Director, Investor Relations. Please proceed.

Thank you, and thank you all for joining us today for Assured Guaranty's third quarter 2007 earnings conference call. Our earnings press release and financial supplement were released yesterday evening after the market closed and these materials as well as other information on Assured are posted in the investor information section of our website. I would also note that our 10-Q for the quarter will be filed by the end of the week and will also be available on our website.

On today's call Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd.; and Bob Mills, Chief Financial Officer will provide a brief overview of the quarter including comments about our credit experience. After their remarks the operator will poll the audience for questions. Please note that this call is being held for the benefit of analysts and investors and Assured Guaranty. Members of the media are welcome to listen but are requested to please call me directly with any questions that they would like management to address. You may reach me in our Bermuda office all day today and tomorrow morning at 441-278-6665.

I would also like to remind everyone that management's comments or responses to questions may contain forward-looking statements. Such as statements relating to our business outlook, growth prospects, market conditions, credit spreads, pricing, credit experience, and other items that are subject to change. Our future results may differ materially from these statements. In addition, our outlook on these items may change. For those listening to the webcast please keep in mind that more recent information on Assured may be available in later webcasts, press releases, or SEC filings. Please refer to the investor information section of our website for the most current financial information on Assured. Please also refer to our most recent SEC filings for information on factors that could affect our forward-looking statements. I'd now like to turn the call over to Dominic Frederico.

Thank you Sabra, and thanks to all of you on the call and webcast for your interest in Assured. As all of you are aware the last few weeks have been very challenging for the financial guarantee industry with enormous scrutiny being applied to our portfolio compositions, credit performance, and mark to market calculations. I want to start by affirming to you that since our inception Assured has believed in credit discipline, risk management, and financial disclosure transparency. During these tumultuous times we will continue to expand our disclosure where possible to meet your requests for additional information.

Before turning to a discussion of the impact on our credit experience of our residential related asset exposures I do want to cover a few of Assured's accomplishments in the quarter and our evaluation of current business conditions. Consistent with our track record since our IPO we again made progress on each of our critical objectives as we have in each and every quarter since our IPO. As we have previously announced on October 22, Assured posted the best new business production quarter in the Company's history with record production in our financial guaranty direct segment. We had exceptional production in U.S. structured finance and very solid contributions for both U.S. public finance and international. Our transaction count of 90 in the quarter easily surpasses all of our previous quarterly achievements signaling increasing acceptance of Assured Guaranty.

Our direct business opportunities continue to expand as our pipeline at the end of the quarter was again at a record level. We did receive the long awaited AAA rating from Moody's Investor Services for Assured Guaranty Corp. on July 11, which we have been able to rapidly put to use given the widening of credit spreads and the increase in investor demand for Assured's credit enhancement products. I would also note that we received our last state license for Assured Guaranty Corp. from Wisconsin and we are now licensed in all 50 states.

Direct PVP was $133 million, an all time record for the Company. Public finance production was strong. Due to -- however deal count was up with our U.S. public finance team closing 36 transactions up from the previous record of 33 in the quarter. As I mentioned last quarter we entered the competitive bid market and are making strides in that large market although our market share is extremely small providing significant opportunities ahead. Our structured finance business continues to generate outstanding results with the 68% rise in PVP over the prior year.

The quarter had a good mix of business and various asset classes, such as two consumer auto deals, 11 U.S. residential mortgage-backed deals and 15 U.S. Corporate full-debt obligations and trust preferred transactions.

On the mortgage side I would note that our activity was largely in the secondary market this quarter as existing investors sought credit protection on recent vintage deals. All of these transactions have been carefully underwritten, with our revised modeling assumptions including higher loss of varying frequency.

We expect to expand our presence in the flow or new public issue mortgage business but the current combination of market conditions and low new mortgage issuance means that there are limited new deals in the marketplace. I would highlight that we did not underwrite any CDOs of ABS as has been our policy since 2003 and we will maintain that position. Our direct international PVP was up 23% despite a difficult comparison to the prior year. Overall the international franchise continues to develop nicely. We wrote four international pool corporate or CLO transactions, 17 European prime residential deals, in addition to five UK utility transactions. I would also note that we are the lead sponsor of the upcoming Australia Securitization Forum and recently signed a lease to open an office in Sidney in conjunction with the conference at the end of November.

Our reinsurance production results were also good at $32.8 million. As we have stated in the past the impact of large deals tends to exacerbate the volatility of recorded production in our facultative business which is the principle growth driver of this segment. Facultative PVP comprised 67% of total PVP in the quarter and 61% year-to-date. This is in accordance with our strategy. I would also note the prior year's quarter is the last quarter in which we recorded any material PVP from the Ambac treaty which totaled 9.5 million in last year's quarter.

Let me now turn to the credit discussion. As many of you are aware Assured has always taken a conservative underwriting approach. This is currently manifested by our lack of material exposure to several distressed asset classes which has put us in a very solid position compared to the industry given rising concerns about U.S. RMBS and related credit exposures. As you know, we have not written CDOs of ABS since 2003 and the 2.2 billion of remaining exposure that we have in that asset class which is rated all AAA with static pools of AAA rated collateral is performing as expected. None of the collateral in those transactions have been downgraded by any rating agency or by Assured. Performance has been strong and does not suggest any potential losses.

On a more granular level in this class we have only one exposure where a sub prime residential mortgage exposure represents 32% of the collateral pool. All of the collateral is still rated AAA today. Additionally this specific CDO exposure expires in April of 2008. Fitch recently recognized the strength of our capital base and our solid risk profile when they announced this Monday that they were beginning a capital analysis project for the financial guaranty industry. In this announcement they bracketed the guarantors by probability of potential additional capital requirements to maintain their Fitch AAA ratings. Assured was only one of two companies to be identified as having the least exposure to additional capital requirements from this new study. This was due to our negligible exposure to CDOs of ABS and the high credit quality of our mortgage book of business.

As we disclosed in our financial supplement and press release our portfolio continues to be highly rated based on our own internal rating standards which generally results in ratings at or below the rating agencies shadow ratings on our par insure. While market opportunities have expanded we have maintained our underwriting standards across all asset classes. Our total net par outstanding continued to have an average rating of AA minus with over 40% of outstanding par rated AAA based on these internal standards. Our below investment grade and CMC list decreased again this quarter to the lowest level on a dollar and percentage of par outstanding basis since our IPO.

During the quarter we continue to be very selective ensuring that all deals written meet our stringent standards that have been updated to reflect current market experience in certain asset classes. Specifically our assumptions for frequency and severity for RMBS exposures represent a current stress view of recent market conditions. 77% of the business written in the current quarter was rated AAA. Our U.S. RMBS book which totals $16.4 billion is spread across four types of asset classes, prime, alt A, HELOC and sub prime. While underlying mortgage delinquency and foreclosure severity have risen, and we expect them to continue to rise, our policy of AAA attachment points on sub prime since our IPO has provided us with excellent credit protection. Our post-2003 direct sub prime book currently has an average over collateralization of 39% and our current conservative expectation is for cumulative losses of 14 to 15%.

We recently did an updated break-even analysis on each transaction and we determined that the underlying cumulative losses would need to rise on average above 29% of the original pool balance before we would incur losses. Cumulative losses on the underlying collateral in our transactions thus far have been only 1%. More recently we've been focussed on an examination of our HELOC book of business which totaled $2.5 billion at September 30, 2007, of which $1.6 billion or 65% is in the direct segment and the remainder is in the reinsurance segment.

In the direct segment we have a short list of transactions, only seven deals with three different services. 91% of the exposure is with Countrywide and the preponderance of that exposure is in two public deals; Countrywide HELOC, 2005 J where we underwrote classes 1 and 2 in the fourth quarter of 2005 and Countrywide HELOC 2007 D which we underwrote in the second quarter of 2000 under tightened underwriting standards. You should note that we did not write any direct deals in 2006 due to our concerns about terms and conditions, such as the use of HELOC as piggy-backs seconds that are used to buy investment properties and the general deterioration in first and second lien underwriting standards. We also stopped writing facultative reinsurance on HELOC business early in 2006 for our reinsurance book.

To date our direct HELOC exposure is experiencing increased delinquencies and we have not paid any losses. Our 2005 and 2007 Countrywide transactions which have public data on Intech have experienced a spike in collateral losses in September and October, but still have significant credit enhancement remaining. Additionally SX spread which may be higher than originally expected due to the slowing of prepayment speeds is being used to fund future losses and any excess will be used to build up further credit enhancements. We continue to closely monitor our performance and stress test the remaining loans. Even in high stress scenario, losses if any are not expected to be material given the modest level of our exposure and the level of credit support engineered in each transaction.

In summary, Assured's portfolio of RBS risk will experience some credit stress compared to original expectations, principally in our HELOC exposure. But in most instances we continue to believe that the probability of meaningful loss which we would define as an aggregate loss of $100 million is extremely remote. We're completely fluent in the details of our portfolio and we will continue to keep you appraised of our experience as the pool of insured mortgages continues to mature.

Finally, through all the crisis and stressful experience over the past few weeks a few further observations can be made. First, Assured has clearly demonstrated underwriting principles and competency in this market and has garnered broad market acceptance. Secondly, the market will reset itself as we pass through these challenging times as to our trading differential to our peer companies, an incredibly critical element of our strategy and future success. We believe based on a host of factors including the current credit default swap prices for the entire financial guaranty industry that we should significantly accelerate our time frame for trading parody to our longer established peers. This will have a significant impact in terms of production, profitability, and capital. Now I'd like to turn the call over to our CFO Bob Mills who will discuss the financial results of the quarter in more detail.

Thanks, Dominic and good morning. I want 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.

Now, turning to our performance for the quarter. Operating income 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, for the third quarter of 2007, is $48.2 million or $0.70 per diluted share compared to $39 million or $0.53 per diluted share in the third quarter of 2006. Assured had a net loss for the third quarter of 2007 of $115 million or $1.70 per diluted share compared to net income of $37.9 million or $0.51 per diluted share for the third quarter of 2006.

Let's look at the results for the quarter in further detail. PVP or the present value of gross written premiums totaled $165.5 million for the quarter, up 30% compared to $127.4 million for the third quarter of 2006. PVP for the direct segment was $132.7 million for the quarter, up 46% from the third quarter of 2006 and was the principal contributor to the Company's record PVP in the quarter. Production in the direct segment included strong performance across all sectors of the business as widening spreads resulted in increased demand and improved pricing. PVP for the reinsurance segment totaled $32.8 million, a decrease of 10% from the third quarter 2006 amount, of $36.5 million which was largely due to the non-renewal of the Ambac treaty which had generated PVP of approximately $9.5 million in the third quarter of 2006.

As Dominic mentioned, facultative activity was the principal source of new business in the quarter rising more than 100% over that of the prior year. Net earned premium for the quarter total $56.2 million up 8% from the third quarter 2006 amount of $51.9 million. For the financial guarantee direct segment net earned premiums totaled $31.7 million for the quarter, compared to $21.8 million in the third quarter of 2006 an increase of 45% from the prior year which is reflective of the overall continued expansion in our direct book of business as well as $1.1 million in refunding net earned premium from a U.S. public financed transaction.

Net earned premiums for the reinsurance segment were $21.6 million, a decrease of 15% from the third quarter 2006 amount of $25.4 million. The decrease was the result of decreased refundings as well as the fact that a number of shorter dated structured contracts are maturing while much of the recent business has been longer dated contracts. Net earned premiums for the mortgage segment were $2.9 million down from the third quarter amount of $4.9 million in 2006. The decrease reflects the continued run-off of the business in this segment during the quarter as well as a $900,000 premium received in the third quarter of 2006 due to a commutation of a reinsurance agreement. There was no new business written during the quarter as was our expectation.

Loss and loss adjustment expenses incurred totaled $3.7 million for the quarter, compared to $0.9 million for the third quarter of 2007. There was a net increase in case loss in LAE reserves in the reinsurance segment related to an aircraft transaction underwritten prior to our IPO, but no major changes in other case reserves. The largest item impacting the expense for the quarter was the updating of rating agency severity factors in our portfolio reserving model based on recently issued data which totaled $6.4 million.

The investment portfolio increased $149 million from the balance as of December 31, 2006, the result of normal operating cash flow. Yields were up slightly comparing the third quarters of 2007 and 2006 with pretax book yield of 5.2% at the end of the current quarter, while we increased the duration to 4.4 years. There has been no significant change in the investment portfolio asset allocation during the quarter. And the average credit quality for the portfolio remains at the AAA level.

Operating expenses increased by $3.4 million or 21% in the third quarter of 2007 compared with the third quarter of 2006. The increase was attributable to a number of factors including expanded head count since the end of the third quarter of 2006, as well as expenses related to share grants vesting over a four-year cycle and share-based grants to retirement-eligible employees which are recorded on an accelerated basis. The level of all other operating expenses remained relatively flat in the third quarter of 2007, and continues to be in line with our expectations.

Income taxes on operating results for the quarter were a recovery of $1.3 million. This is the result of a $6 million reduction in our estimated U.S. Federal tax liability due to the finalization of an IRS audit associated with 2004 and before for some Assured's subsidiaries. Absent this recovery the effect of tax rate on operating income was 10% for the current quarter.

As many of you are aware, financial guarantee contracts that are written in credit derivative form must under U.S. GAAP be mark to market and provide protection against payment default on underlying security, not a change in market value. As disclosed in our press release dated October 22, 2007, we had after-tax unrealized losses on derivatives of $162.9 million. This was totally attributable to spreads widening and included no credit losses. The derivative business is an extension of our financial guarantee business and these guarantees in derivative form are not traded nor are we generally required to post collateral based on changes in market value. As these instruments approach maturity, market fluctuations, gains or losses will revert to zero, absent a specific credit event. Changes in the mark to market have no impact on statutory capital or rating agency models .

More than 70% of the mark to market was due to our corporate CLOs and in particular our high-yield corporate cash flow CLOs, 100% of which are rated AAA. I would note that the widening of spreads in the CLO market is due to a mismatch of supply and demand in that market, as underlying corporate credit performances remain strong. The balance of the mark to market was mostly attributable to the decline in sub prime secondary market prices for our RMBS and commercial MBS book which is almost entirely rated AAA.

The net position on the balance sheet related to the mark to market of derivatives as of September 30, 2007, is now a liability of $202 million before tax benefit. With considerable volatility continuing in the market, this amount will fluctuate in future periods. There has been little movement in the mark to market since September 30, for corporate CLOs, the largest component of our mark. I would note that the sub prime market prices have continued to deteriorate since the end of the quarter. The actual mark to market for the fourth quarter will of course depend on market prices as of December 31, 2007. You should note that our 10-Q, which will be filed shortly, will include a sensitivity table for mark to market valuations which should provide some clarity into our mark to market valuation level.

Our book value per share was $23.69, a decrease of 1% from the $24.02 book value per share at the end of the third quarter 2006. Our book value per share number includes about $2.20 a share for the net unrealized loss on derivative contracts as of September 30, 2007. Adjusted book value which reflects the book value and adds the embedded value from after tax net present value of estimated future installment premiums in force, and after-tax net unearned premium reserves net of debt was $37.57 per share at quarter-end, up 9% compared to $34.43 per share at the end of the third quarter of 2006. The growth in adjusted book value reflects strong new business production over the last 12 months. It was partially offset by the mark to market unrealized loss on derivatives.

The Company's operating ROE which is calculated by dividing our annualized quarterly operating income by average shareholder's equity excluding accumulated other comprehensive income and the effect of the unrealized mark to market loss was 11.4% in the quarter and year-to-date compared to 9.4% for the third quarter of 2006 and year-to-date 2006. With that, I'd like to turn the call over to the operator to poll for

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Geoffrey Dunn with KBW. Please proceed.

Good morning. We're hearing some feedback out there that the rating agencies are getting maybe a little overly aggressive on downgrades, not necessarily looking at full transaction merits but maybe basing down rates just on collateral performance. I'm in the camp, I don't think you're going to have material losses, nor do I think any of your peers will, but incrementally do any of the rating agencies actions worry you that maybe more indiscriminate downgrades could pressure capital charge requirements inside the Company with losses not really being an issue?

Jeff, our view is we rate everything internally so that the rating agency ratings are kind of like a, either secondary check guidepost but principally we rely on our own ratings, we assess our own capital requirements off of that. Although, as you point out, we're subject to their current requirements and that is why our current conservatism over our capital, because quite honestly we don't know where this is going to go relative to capital needs based on the downgrading and then their stress modelling. So we don't have it influence our underwriting. That is done off our internal structure and system and standards. We are mindful of their current concerns and potential reaction to the current market and, therefore, position the Company to ensure that we have the capital required to continue to maintain very strong levels of AAA ratings.

Right. Thank you.

Next question comes from the line of Mike Grasher with Piper Jaffray. Please proceed.

Good morning. Dominic, you mentioned some discussion there on trading differentials. Where are those differentials now, how have they changed over the past 90 days?

Mike, we've had historically been pulling in the trading differential and it probably starts back two years ago as we started to move up the ratings scale in terms of the AAA ratings. It's harder to now provide real points because there is not a lot of transactions being done. On the structure finance side, we have no real side by side comparisons, but market participants typically point to the default swap levels and we are quickly becoming a preferred provider and we there with price are very close. Obviously the real issue for us and the real opportunity is in public finance.

And in public finance we've been able to get to a position of parody for floating rate but the Fitch rate, and this goes back to the issue of how many transactions we're going to actually be able to point to. We're currently in a rating or a differential of about 5 to 7 points and yet obviously our argument is extremely powerful relative to the rationale as to why we should be trading flat, if not inside, by playing to go a whole host of different data points, including the credit default swap prices for ourselves against those other guarantors. So as I said in my opening comments, there is our expectation that this market should reprice, it should reprice significantly in our favor, and that being the case, even though it takes some time, that will provide us tremendous opportunity for the Company to grow in that very valuable asset class called public finance.

It leads me to my follow-up which is how much has the market changed for Assured and what does your pipeline look like today? Has it accelerated given the current environment?

Our pipeline today as I said earlier, is at record levels, and I would tell you that it is at record levels almost at a multiple. So we don't typically give out the exact number. The only thing I can say to you is on a year-over-year basis we look like a very different Company. You're looking at in terms of just giving you a quantification, triple what it was last year at this time.

That's helpful. Okay. Thanks. And then, Bob, just I wanted to I guess pry you a little bit here, as a former banker, there seems to be a lot of confusion out there around the mark to markets between the banks and between the financial guarantors. Can we get your thoughts in terms of what some of the -- where some of the confusion may lie in terms of how the banks perform their mark to markets versus what the financial guarantors do?

It is somewhat difficult to comment on what each bank is doing, since I am not in there. Certainly I worked on that side of the fence, too, and I believe the discipline or the mark to market concept is the same, regardless of where you are. From the mark to market standpoint I believe we use a rigorous approach to this to the extent that we can we use direct quotes. Beyond that, we rely on market indices, the JPMorgan high-yield cash flow, AAA index for our high-yields, the ABX index and CMBX index for our residential and commercial mortgages. Beyond that it becomes more limited use of counter-party marks or similar transactions, but that is very limited. You must remember, too, that 97% of our CDS are all AAA rated. So it is hard to comment on what the others are doing. I do it the same way as I did when I was on the bank side. Use a very strict methodology.

I'm going to step out on a big limb here and get on a little bit of a rant. Part of what you're seeing in the hysteria in the market today I believe is because of the mark and the misunderstanding of the mark relative to financial guarantee companies. We're not priced on a spot basis, we do not have exposure relative to a change in price, we pay only on credit events. A significant portion of the mark deterioration today comes out of the residential side. We've gone through in this call in our website an exhaustive explanation of our exposure. We've quantified for you the worst possible maximum exposure we have. It has nothing to do with our mark. Our biggest exposure today that we believe that could result in losses is HELOC exposure which is not even in the mark because they're financial guarantee contracts. The mark is not a surrogate for losses, it can't be looked at that way, each of us has to come to a recognition of our exposure relative to the residential marketplace as it is today and recognize there is potential losses period, end quote and the market is not relative at all to that discussion.

Thank you for that feedback, that's helpful and hopefully the market will figure it out some day.

We hope and pray along with you.

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

Good morning. I was hoping to talk more about your HELOC exposures. Can you give us a sense of what cumulative losses those can sustain, what happens if prepayments slow and then also give us a sense of the -- what sort of stress testing you put these through?

Okay. Darin, this is an extremely complicated exercise, because there are so many assumptions that go into the ability to forecast expected outcomes. So if you think of the result, these are basically second, the HELOCs, they sit on top of prime. So the first thing you really have to understand what are the mortgages below you, the type of loans they are, because that has an impact on the second position. We look at that in items of starting to develop our expectations of what I'll call default factors, right, so that's delinquencies that ultimately confer to a default.

We do stress it significantly beyond by looking at today's current array of current borrowers, delinquents, and stress each class to an assumption of how much will go into default. For the sake of argument everybody above, say, 180 days we consider even though they're only delinquently listed today, they're 100% going to go into default. We then also further stress it by saying that everything is 100% severity, there will be no recovery. Every time we look at our expected loss in that model we take the worst position.

The real wild card here is the excess credit, these deals start out with virtually no overcollateralization or credit enhancement and it is built up by the trapping of the excess spread. So you hit the pre-agreed level of credit enhancement. As prepayments slow the amount of excess spread which is typically in excess of 200 basis points then continues to build. It pays losses as well as builds up additional protection. That is the wild card today. We normally assume a prepayment rate, kind of in the 30% level. And based on what we're seeing today, that's starting to slow down, so probably down to a level of 15, that has a significant impact on the level of buildup of credit enhancement.

We think our deal structure today can absorb a loss somewhere in the 8 to 12% range of the original pool balance. Current default or current losses today in the structure are at 1.4%. The 2000 deals are written -- our 2007 deals are written even tighter so there we think we can get up to as high as 14% enhancement before we would ever be looked at to pay a loss. Also remember these are spread over seven deals, so they're not huge in and of their own right. For instance, if you look at the Countrywide deals with roughly about 700 million of par still outstanding, 1% movement above our expectation of loss containment is a whopping $7 million. So as you can see, even if our expectation is it will go to 10, and we cover it. If it goes to 20, that's $70 million of impairment before tax.

So we look at it tight. We try to estimate as best we can the negative side which is the foreclosures and the severity, which we take very conservative views. The wild card is how much continued enhancement we will build from the excess spread and that is really related to the prepayment factor. We look at that at 30% now, we think it's probably really around 15. As that modifies it will give us more enhancement to protect losses. But as I said, even in the absolute expectation of, it doesn't come out the way we think, everyone points about $7 million.

That's very helpful, Dominic. I guess turning to a different subject, on reinsurance, if some of your competitors do come under capital pressure and they're looking for ways to free up capital and they seek reinsurance as a solution, would Assured Guaranty be willing to offer that?

My gentleman who runs the direct businesses is madly scribbling on a pad of paper that you would rather not. We are committed to both sides of this industry, both on a reinsurance side and a direct side. We will be opportunistic on how we utilize our reinsurance capital. The current market, as you point out, should send a lot of the existing guarantors to seek reinsurance protection. We're aware of that. That becomes in effect our market, and that's kind of why we're here and that's what we're built for.

Great. Thank you very much.

You're welcome.

Your next question comes from the line of Mark Lane with William Blair & Company. Please proceed.

Good morning, everyone.

Good morning, Mark.

Congratulations on getting that last state license in Wisconsin, by the way.

It was a significant point, Mark. I wanted to make sure you understood that.

I've been waiting for that.

We passed out cheeseheads this morning.

My question is, on excess capital, I don't know if I missed it, but Bob, can you talk about, quantify that potentially, at least within a range based on the different ways the rating agencies look at that?

Yes, it's -- it is done differently by all three rating agencies. And , when you look at the -- their last published data, the excess capital would be, depending upon who you're looking at, somewhere between $300 million and $685 million depending upon which rating agency you're looking at. So there is quite a substantial amount of excess capital that still exists

And, while your credit quality is extremely good on the RMBS side, can you give us any sense of the -- what sort of downgrade risk in terms of capital requirements you might have?

I mean not surprisingly, we have looked at downgrade risks associated with our sub prime and prime exposure and we clearly have enough capital under a reasonably severe downgrade scenario from -- for sub prime, and we're prime exposure from any of the rating agencies at this point. I don't see it to be a big problem.

Okay. The last question is -- and I don't know if there has been enough time--the market has been kind of seized up, but regarding the business on a day-to-day basis, I don't know, you mentioned trading differential, but what is the dialog right now among your customers, their comfort with the financial guarantee product right now? At least anecdotally what sort of discussions are you having? Are you concerned at all about wavering demand or just the scrutiny on the business? Is it -- has there really been a change in the last week or two, or is it just more rumors and et cetera.

The biggest change, Mark, obviously we're committed and believe in the industry and its viability and its necessity in today's capital markets as a means to accomplish financing that would not get done in any other format. If you look at dialog, obviously the easiest thing we can point to is our pipeline. As we said it is triple what it was last year, and no one is walking away from the table. Deals are getting postponed due to liquidity crisises. But it separates the market. International goes on as it goes. Public finance goes on as it goes. It is really in the structured credit where true cash deals, or public deals, are drying up for the short-term as liquidity has kind of left the market. However, there are tremendous opportunities relative to basically on balance sheet risk management that are kind of filling up our coffers. And the neat thing about this business is it really gives us the ability to choose the asset classes.

Obviously going forward, as the market works its way out, some of these non-bank SIDs will obviously go away and that is not a real loss for the industry. Obviously we don't expect CDOs of ABS to be a very popular item going forward. Once again, since we didn't write any of that business, it is not a concern of ours. Are we necessary? Absolutely. Are we involved in active dialog with all of our constituents out there in the marketplace? Yes, we are. Is there a lot of activity today? Sure there is. But there are segments of the market that because of liquidity crisis, which we do believe corrects itself. At the end of the day these things have to ultimately get taken care of or done in the market. We are, I would say, on the lips of most people that are looking for credit protection as one of the premier guarantors that they want to do business with on a go-forward basis.

Last quick one, Bob, the portfolio reserve and then direct. You mentioned some change in rating agency stress analysis or something. Which rating agency or which sector are we talking about?

I mean, we do this every year. But on September 6, S&P put out some new severity information for ABS, and we put that new information, as we always do, into our model, and that resulted in an increase in the portfolio reserve as I said of $6.4 million.

Remember, Mark, we do portfolio reserves on every risk in our portfolio. It really keys off of default assumptions and severity assumptions that we use published from the outside, so it is very independent. It is the S&P, default and severity, and because they changed as of September 6, which they typically do every year in the third quarter we then update our statistics, so when our machine runs our portfolio reserve has the higher severity, principally with severity this time; higher severity risk that caused us a $6.4 million increase in reserves.

Got it. Thanks a lot.

No problem.

Your next question comes from the line of Jeff Bernstein, with Lehman Brothers please proceed.

Hi, very similar question to the one before but I'll ask it again, I guess from your customers' standpoint. With what is going on in the press, the equity markets, and your own CDS levels, how does the customer remain comfortable that it is a good decision given the way the market -- and I agree it is irrational, but the way the current is currently valuing you and your peers, both equity and fixed income?

Well, it is kind of a, almost a parallel shift. Right? So our spreads have widened in terms of default pricing, but in most cases on the ABS side, so have the underlying assets. So since both of why now the amount of benefit that you're going to achieve from us providing the rap is still providing the benefit. Number two, people, although we bring around those credit default swap prices table with us, we see certain that desks in terms of pricing our risks they are not that widely adhered to or used in the current argument. So we still provide value, we still provide the access to the capital markets in liquidity. And, therefore, we're not having those kind of halting conversations that you might expect based on the other kind of noise that is going on today in the marketplace.

Thank you.

You're welcome.

Next question comes from the line of Heather Hunt with Citigroup. Please proceed.

Thank you and good morning.

Good morning Heather, how are you.

Fine, how are you? I wonder if you could talk about the dynamics of your new business this quarter? It looks like you went towards more conservative products, given that your premiums to par didn't really increase very much, and just looking on the schedule it looks like more GOs, et cetera. Can you describe why you've moved toward that? I am assuming it is because you can get better pricing for lower par. But it would seem like you could get some really good pricing this quarter.

Heather, as we talked a little bit about our book will start to transition as our current AAA ratings across the board take hold. Where we're going to be able to see more of that traditional, very safe business. Remember, in the old days we were under a market share requirement from Moody's which we've always taken strong exception to in terms of financial separating. It forced us to write high par, low premium but we never skimped on the credit quality. So we wrote those AAA attachments. Today we've able to look at a broader mix of the business and all asset classes, yet for us in today's market, we're being very conservative on how we utilize that new-found pricing power and those areas of the market that we're willing to put our capital at risk, because part of it is we believe there are significantly better times ahead, part of it is you definitely walk before you run, and that we're building up our diversification of the book or the portfolio, as well, across these kind of new areas that we haven't previously written before. And we obviously handled the opportunities we get and what our marketing efforts have provided us. That will continue to evolve and change quarter to quarter.

Okay.

The book is, if you had asked me a year ago, post-AAA, what would be the mix in terms of rating of your business, I would say we would be moving out of the AAA world. We see no reason to do that at this point in time. You're getting paid very, very well for taking that very high rated, very safe level risk. Preserve capital but at the same time move up profitability and overall production. So it is a good part of how we're looking at it today.

Okay. I thought it was something like that. And are you seeing opportunities in the last few weeks to maybe do deals where some of your competitors who are a little bit more in the headlines are not as active, just in the last few weeks? Is there at all a change in the tone?

We are doing a lot of secondary deals, Heather, exactly as you pointed out. And one of the comments underlying Bob's remarks on mark to market exposure, some of our current fluctuation potential mark is relative to the swap pricing on our peers, and how it is going to affect the mark. So we are doing a lot of rap on raps if that is your question.

Thank you very much.

You're welcome.

Your next question comes from the line of Tamara Kravec with Banc of America Securities.

Good morning, everyone.

Good morning.

Couple of questions. The reinsurance transaction, the HELOC, the $1.8 billion, any thoughts on risk of further downgrades of that or do you think it has been reviewed and that's it? And then on the reserve increase in the direct business, just a follow-up to somebody's question about what -- how different now do you think your severity assumptions are, were you just kind of moving through rating agency assumptions or did you take an extra look at it and move even more conservatively beyond that in terms of assumptions there? Then my final question is just on head count and looking at the pipeline that you've got, given the market conditions, do you anticipate your operating expenses or head count having to rise more dramatically than you may have thought?

Okay. If I can remember them in the order that you gave them. On the HELOC side, remember we only have about $2.5 billion, almost 1.7 is direct, so the rest is reinsurance. And that reinsurance is spread over a host of transactions, 66 deals to be exact, the largest being $90 million. We've got every one of those listed, posted, stressed. We're concerned that there could be some losses arising because a lot of them are written at the BBB level. But individually if you looked at the mean, the mean exposure is probably about $7 million in any one given deal. So once again use the percentage methodology, even if we blow the expected outcome, 1 percentage point is $700,000 it is not going to be material, right?

Right.

And we did no facultative in '06 where you would see a larger size session coming to us. The treaty has a very limited view of what can be ceded to us. In terms of the reserve, if you can go back over that question again, on the reserve side.

Just wondering what your -- you had increased your severity assumptions just based on S&P and I'm wondering if -- you commented that you use your own internal ratings. The rating agencies are kind of a check, but are you -- was the discrepancy -- would you move beyond what the rating agencies are assuming just to be overly conservative? In other words, I guess, would you feel like you would have to review this again in a year and perhaps it could be higher?

Well, remember, that we're talking portfolio reserves here, which is us being extremely prudent in how we assess potential credit exposure across the entire book of business. Number two, and I should have maybe highlighted this, the critical element that keys the portfolio reserve process is the rating of the transaction because at different rating levels it kicks up higher levels of probability of default and severity. They are our rating levels and about 30% of our book has a rating level lower than what the published rating agency level is. So it is our conservative view of the rating.

It then does cede the standard default and severity statistics that get updated annually by S&P and we do that purely for independence, purely for ease of audit and understandability and transparency. Obviously that is only for the portfolio. Once we start to look at the specific credit issue in any other content besides portfolio, we then start to apply our own reserving process. So the portfolio, think of it as a book mark. It is a place holder to ensure that we constantly look at our entire portfolio and understand the ultimate potential expected exposure that it contains today based on our rating and based on what we consider very reasonable estimates of severity and frequency. Once we start talking true loss possibility, that goes out the window, and it's all done with our own internal view of losses. Right? Our underwriting standards use our severity, so separate that from when we underwrite new business.

Head count.

Head count.

I'll do that. From a head count standpoint we have grown in the last year. At September 30, of '06, the head count was 131. Today the head count is 144. We are expecting to continue to grow head count into 2008. Naturally in this market there's probably some subjectivity as to how and when that will grow, but considering the opportunities that we see, we will continue to expand our head count to meet those needs.

We've obviously completed our 2008 plan, and in the plan the head count addition is, I think--?

About 8%.

110 or 11 people in total.

144 now to 156 in the plan.

But that will depend on opportunity. Obviously I think we've been trying to manage that very reasonably. We had to build it before it came early on to make sure we could handle business and assure execution. We now have been adding to the staff as opportunity arise, and obviously based on the change in this market you could see some significant opportunities develop that we would then have to be responsive in terms of staffing up for. Currently our plan is for a very reasonable moderate level of increase.

Okay. Great. Thank you so much.

You're welcome.

Your next question comes from the line of Bob Ryan with Merrill Lynch. Please proceed.

Good morning.

Hey, Rob, how are you doing.

My question is in your ancillary mortgage business, what was the last time that you took on any new exposure there and what is the nature of those exposures?

Wow. They're -- the last time, all I can tell you is the deals expire in three years. It was the last deals, they were like 10-year deals. They're excess of loss, soft capital-type programs written under the old -- old Company structure and business plan. We did do a reinsurance deal in the UK in '04 and that was the last deal that we've ever written. So they're high up, principally excess of loss. At one point in time we did get them rated, because we felt that they were sort of like RMBS but a very high AAA type of attachment. They're highly seasoned. So they're long outstanding deals. So they don't suffer some of the current pang. We have got 1.4 billion of pars still out there and that continues to amortize down.

Great. Thank you.

You're welcome.

Your next question comes from the line of (inaudible). Please proceed.

Yes, good morning, hi Dominic and Bob. I wanted to ask a couple of numbers questions and then bigger picture on the reinsurance side. On the numbers side, when we think about total capital resources, obviously qualified statutory capital, present value of installment premiums, one element I didn't see and I might have missed was the soft capital facilities. Could you just remind us what if any you have in that regard and/or any other items that we should be thinking about?

Sure, we have two soft capital facilities. One is a bank soft capital facility which is at AGR in the $200 million, which was put into place just recently in 2007, replacing an older facility. And we have a capital markets facility of $200 million at AGC. That was put on really as a term facility and that facility rolls over, is up to be reissued in April of 2008.

Bob, on that second one, is, in the event you would need to tap it, for whatever reason, even if it's just to give the agencies greater comfort, is that facility dependent on availability and the opening of the asset-backed mark? Do you need to rely on--?

No, it is a funded facility. It is not subject to auction. But I must tell you, I cannot conceive of a circumstance where I would have to draw upon that facility.

Excellent. Thanks for clarifying it. And maybe Dominic, on the reinsurance side of the business, I guess first by way of disclosure, have you guys provided much granularity about some of the other financial guarantors that you have exposure to? And I guess given an environment where one would suggest that the terms of trade would favor reinsurance how do you think about growing that on a go-forward basis.

In term of granularity exposure to the other model lines, remember we underwrite every deal on the reinsurance side that we see facultatively regardless of who is the primary writer, so it's got to pass our underwriting standards. On the treaty side we only have the one treaty. No, I guess we have two today, where we specified parameters that in effect determine the type of business that can be ceded to us. In both cases, if that is your question on exposure of the other model lines, we're very comfortable with the underwriting risk, and obviously it goes through the same process that we use, when we underwrite on the primary side, as well.

Dominic, just to clarify, you don't have exposure below AA, AAA folks, do you? I guess the question--?

As reinsurer, that cede to us, no. We only take reinsurance from the existing AAA model lines.

Excellent. Thanks. Then just finally, on the environment for growth given your strong ratings and obviously the demand pool?

We're blessed on both sides. We see tremendous market opportunity on both the reinsurance side and the direct insurance side and there is a constant taffy pull in our Company relative to capital and limit allocation between the two groups. As a Company that does service the third-party ceding reinsurance marketplace, meaning the other AAA model lines, we're serious about that business. We have to allocate capital to that business and service that market. Obviously we see tremendous opportunity there. We're well positioned by being head quartered in Bermuda with that specific entity so that the, in effect economics that we get on a reinsurance basis is as good if not better than the primary Company ceding to us. So there's no loss to what we'll call profitability from that point of view. However, the direct business that we also utilize through that reinsurance mechanism gets also further enhanced, so there is a good argument on both sides of the fence. The one thing we've always liked about having a foot in the reinsurance door is it does spread our portfolio out, it does allow us to look at basically every opportunity in the marketplace where we can be further selective from an underwriting point of view.

Thanks very much.

You're welcome.

(OPERATOR INSTRUCTIONS) And your next question comes from the line of Adam Star. Please proceed.

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Thank you. Many thanks to you all for joining us today. And we certainly appreciate your interest in Assured Guaranty. As I mentioned, you can reach me in our Bermuda office today at, 441-278-6665 if you have any follow-up questions. I would also note that a replay of this call will be available on our website as well as by telephone at 888-286-8010 in the U.S., and at 617-801-6888 for international callers. The password is 12378747. Please call me if you have any additional questions and we look forward to talking to you soon. Thank you and have a good day.

This concludes the presentation, and you may all now disconnect today.