Assured Guaranty Ltd (AGO) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2008 Assured Guaranty earnings conference call. My name is Josh, and 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 the conference. (Operator Instructions).

I would now like to turn the presentation over to our host for today's call, Managing Director of Investor Relations, Sabra Purtill. You may proceed.

Thank you, Josh, and thank you all for joining us this morning for Assured Guaranty's fourth-quarter 2008 earnings conference call. Our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd., and Bob Mills, Chief Financial Officer.

After their prepared remarks, we will take questions from the audience. Please note that our webcast is not enabled for Q&A, so if you would like to ask a question, please dial into the telephone conference call at 1-800-561-2731 and join the call live if you have any questions.

I would like to remind you today that management's comments or responses to questions may contain forward-looking statements, such as statements related to our business outlook, market conditions, credit spreads and market credit conditions, rating, loss reserves, acquisition and other items where our outlook is subject to change. Listeners are cautioned not to place undue reliance on the forward-looking statements made on this conference call today, as management does not undertake to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

You should refer to the Investor Information section of our website and to our most recent SEC filings for the most current financial information on our Company and also for more information on factors that could affect our future financial results and our forward-looking statements.

Thank you and I will now turn the call over to Dominic.

Thank you, Sabra, and thanks to all of you on the call for your interest in Assured Guaranty. Without a doubt, 2008 was the most challenging year that Assured and the financial markets have ever faced. Our steadfast commitment to strict underwriting discipline protected us from some of the worst of the damage done by poor mortgage underwriting and from the continued economic deterioration. But we nonetheless had to recognize some large losses in our portfolio.

In particular, we have had to absorb losses on our HELOCs and closed-end second-lien exposures. Unlike many other financial institutions, the growth of our earnings base since our IPO enabled us to absorb almost $300 million in pretax losses incurred on our insured exposures and still report operating earnings of $74.5 million for 2008 and $3.5 million for the fourth quarter.

Aside from the losses in our RMBS book, the vast majority of our other credit exposures have continued to perform well in this economically stressed environment. After extensive downgrades of corporate credits and CLOs, our pooled corporate portfolio continues to be highly rated, with 87% of it still being rated AAA. And remember, that is based on our internal ratings.

Commercial MBS and consumer ABS portfolios are also holding up well, with average ratings of AAA and AA, respectively.

In the municipal market, which is experiencing revenue shortfall and budgetary concerns, we've experienced only minor downgrades and have only one major troubled credit, that being the Jefferson County, Alabama sewer system.

I would also note that aside from two life-insurance securitizations that are having stress associated with our RMBS investment portfolios, our structured credit book is performing consistent with our underwriting expectations for this kind of economic environment, which we plan for in our underwriting approach. As a result, our credit challenges still continue to be concentrated in our RMBS portfolio, which did experience additional deterioration in the quarter, consistent with the continued falling of real estate values and the rise in unemployment and delinquency trends.

RMBS comprised about two-thirds of our loss expenses in the quarter and 88% of our losses for the entire year. Bob will go over the reconciliation of these losses in his part of the call. However, I wanted to touch on our outlook for our RMBS losses.

We continue to believe that our RMBS losses are containable, given the limited amount of exposure that we underwrote and our also generally high attachment points. This is not to say that all of our losses are behind us. We continue to increase our loss estimates on our second-lien exposures and expect that we could have some future claim recognition on our Alt-A risk, given the continued erosion of credit enhancement.

However, there is a significant degree of uncertainty about if and when these losses could be incurred, depending on the success of the economic stimulus program, the home foreclosure and loan modification plans and at what level and time the US housing and employment markets stabilize.

As our financial supplement discloses, average credit enhancement on our subprime and Alt-A portfolios is still adequate for current delinquency trends. Additionally, our risk management team proactively reviews our portfolio and pursues any and all means of redress on troubled credits, including litigation, if deemed appropriate.

With respect to the two direct Countrywide HELOC deals, for instance, we have aggressively pursued put-backs under the terms of those deals and have submitted a significant amount of loans for repurchases. Repurchases began in October and have occurred in every month since. The continued success of this process alone could have a significant impact on the level of ultimate loss to be realized.

We expect that the credit environment will remain difficult in the near term, and we also hope that the various programs proposed and still to be considered by the Obama administration will help alleviate some of the fallout in the credit markets. Some of the administration's proposals may be better for Assured than others, but we are and will remain very active on Capitol Hill, making sure that our views are heard. It will probably take several months before we have greater certainty about the impact of these programs on our portfolio, but we think that many aspects of the programs could help the housing market in some capacity.

Aside from mortgages, we are also still active in Washington on a variety of other fronts as well, including the various proposals and discussions concerning municipal bond insurance. You may have heard about the proposal of either starting a federal- or state-funded bond insurer for the municipal market or providing reinsurance capacity to the existing bond insurance companies. There is no question that the municipal market is facing numerous challenges, such as the cost of financing, investor demand, falling municipal revenues and the overall economic outlook. However, we do not believe that the US taxpayer or the municipal market would be better served by starting a nonprofit government-controlled entity. This concept has been tried in many areas with questionable success in the past.

We have always believed that the market needs three to four strong, well-capitalized bond insurers and that direct federal intervention in the bond insurance market would have the effect of driving out private market solutions, thereby making the future of the municipal bond market totally dependent on the federal government, and that is not a very good outcome.

We believe there are more viable options for the government to help the municipal market, such as helping below-investment-grade issuers or providing some level of reinsurance support to support the existing monolines. And we are working at all levels of the government and state regulation organizations in order to help create effective and efficient solutions for the challenges facing the municipal and structured finance markets today.

I would like to talk briefly now about our outlook for 2009. I am pleased with our position today, and I believe in 2009 we will be able to capitalize on our three major advantages. First, our conservative approach to the US RMBS market and our avoidance of CDOs of ABS means that we have containable loss exposure on RMBS and we have avoided the catastrophic losses on the CDOs of ABS. This has allowed us to become the highest rated of any of the experienced legacy bond insurance companies in the market today, and the only bond insurer of that group that has a stable outlook from all three rating agencies.

Our second advantage is our strong revenue base, which continues to benefit from the growth in our franchise. We are growing our future revenue base, not shrinking. And our increased revenue base will help us absorb future losses if they arise. 2008 exemplifies this. We had about $350 million in total credit losses and asset impairments, more than our entire revenue in 2004, but still were able to report both operating profits and net income for 2008. Going forward, the revenue base we have built will help drive earnings growth and capital accumulation, which will in turn allow us to further expand our franchise and increase our return to shareholders.

Third, we are in a unique position in the market today, having ascended to a leading position in the bond insurance business. Demand for our policies remains high. Through last Friday, we have guaranteed about 12.7% of all municipal bonds issued so far this year compared to 8.1% for the first three months of 2008, a 50% improvement. We expected demand for bond insurance to remain strong, particularly in the municipal bond market, where concerns about issuer credit quality are growing. And our leading position and growing name recognition and recognized credit experience will help solidify our market reputation and position in the future, when we expect more competitors.

Taken together, these three factors will help Assured to continue to build our financial guaranty franchise and help us provide highly-rated credit enhancements to fixed income investors and produce a solid, long-term return on capital for shareholders.

I would like to touch on the FSA acquisition before turning the call over to Bob, after which we will open up the call for your questions. As of today, we have many of the regulatory approvals that we need in order to proceed, including Hart-Scott-Rodino clearance and the approval of the UK regulators.

We will be holding a shareholder vote on March 16 to approve the issuance of shares to Dexia and also for the sale of shares to the WL Ross and Company that were part of the original purchase proposal. However, we hope the public market will offer us a more attractive financing option than those previously set share levels in the original agreement.

We expect to receive approval from New York and Oklahoma regulators in March, as well. In addition to these approvals, we expect to review the separation of FSA's financial products subsidiary, as well as the combination of our companies with the rating agencies in March, and hope that we will receive their ratings conclusions by the end of March in order to affect a closing either in first or second quarter.

We continue to be excited by the opportunities that this acquisition will provide to Assured and its shareholders, given the combination of the two companies' talent and balance sheet strength.

While the credit losses in RMBS continue to be a major disappointment for both of our companies, they are nevertheless within the stress range that we anticipated when doing our due diligence. We expect the FSA transaction to be accretive on an earnings and ROE basis, and look forward to completing the transaction so that we can move forward together as the leading financial guaranty company in the market today.

I would now like to turn the call over to Bob to discuss our financial results in more detail, and I will be happy to take your questions at the end of Bob's comments.

Thanks, Dominic, and good morning. I would like to cover some brief highlights of the quarter. Please refer to our press release and financial supplement for further details on our financial position and results of operation, and also to our 10-K for details on full-year 2008 results.

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 credit derivatives, for the fourth quarter of 2008 was $3.5 million, or $0.04 per diluted share, compared to $37 million, or $0.53 per diluted share, for the fourth quarter 2007. The principal reason for the decline in operating income is that we had pretax loss and loss adjustment expenses for contracts written either in insurance or credit derivative form of $114.8 million, or $0.97 after-tax per diluted share.

Our PVP, or present value of gross written premiums for insurance and credit derivatives, totaled $128.1 million for the quarter, down 73%, compared to $477 million for the fourth quarter 2007. This reflects the lack of any large reinsurance transactions, as last year's results included the Ambac portfolio reinsurance transaction, as well as the decline in new structured finance business and international business production in the Financial Guaranty segment.

Direct US public finance business, on the other hand, experienced a significant increase in demand and market penetration during 2008, even after the downgrade from Moody's midway through the fourth quarter. Our direct public finance PVP rose 124% in the quarter to $57.4 million, with more than 462 transactions in both the new issue and secondary markets, compared to the 84 transactions we did in the prior year's quarter.

As Dominic mentioned, our revenues grew significantly during the year as a result of our new business, as well as refunding premiums. Net earned premiums and earned revenues on credit derivatives for the quarter totaled $105.7 million, up 56% from fourth quarter 2007, with growth in both direct and reinsurance. This amount included $24.4 million of refundings in our reinsurance segment, which is lower than last quarter, but is still running at a much higher than normal amount due to the continued refinancing of auction rate securities and other variable rate debt that were guaranteed by other financial guarantors and then reinsured to us.

Net earned premiums and earned revenues on credit derivatives, excluding refundings, were $79.9 million, up 21% from fourth quarter 2007, and reflect the significant increase in new business underwritten over the last 12 months.

As Dominic discussed, the growth of our business over the past several years, combined with the stability of our earnings model, gives us a great deal of visibility into the future revenue growth levels. The source of most of our revenues for 2009, our invested assets and our unearned premiums, is already on the books.

To further illustrate our earnings model, just based on the business we have on the books as of December 31, 2008, we expect net earned premiums and credit derivative revenues, excluding refundings, of almost $309 million, which you can see on page 16 of our financial supplement. The FSA acquisition will further increase our revenue base after it closes.

Consolidated loss and loss adjustment expenses incurred, including losses incurred on credit derivatives, and consistent with our prior-year accounting methodology for loss reserves, totaled $114.8 million for the quarter, compared to loss expenses of $18.1 million for the fourth quarter 2007. These losses incurred were largely related to US RMBS, and in particular, Alt-A first-lien RMBS of $15.7 million, closed-end second-lien transactions of $24 million and HELOCs of $24 million. These transactions that generated these losses have all been on our CMC list so they are not new troubled credits. However, the continued deterioration of the economy beyond what was expected accelerated delinquencies in these transactions.

We did have two credits outside of the RMBS category where we posted loss reserves in the quarter, both of which have been long-identified on our CMC list. We posted case loss reserves of $6 million on Jefferson County Sewer, the troubled sewer system in Alabama that has been exacerbated by the authorities' use of interest rate swaps and the collapse of the auction rate securities market.

We also posted approximately $17 million in case reserves on a life-insurance securitization. The loss on this transaction is not due to the performance of the life mortality exposure, but rather due to the improper investment of the collateral account in subprime and Alt-A mortgage securities by the investment manager.

Our fourth-quarter 2008 balance sheet included about $49.8 million in accrued loss reserves for credits not on our CMC list. As discussed in prior quarters and disclosed in our SEC filings, during first quarter of 2009, we will be implementing FASB Statement Number 163, which affects several items on our income statement and balance sheet, but most notable will change our reserving approach. Going forward, loss reserving will be tied to specific transactions identified on our CMC list only. We will no longer record portfolio reserves on an inherent loss basis.

Our total insured portfolio experienced some deterioration during the quarter, principally on RMBS-related credits, but has otherwise held up well, given the poor credit conditions market wide. Our closely monitored credits list increased by about $2 billion in the quarter, principally due to the addition of $1.5 billion for two Alt-A mortgage-related exposures in our direct segment. Summary information on our RMBS and other asset classes can be found in our financial supplement. In addition, specific transaction lists are available with CUSIPs on our website, and you can use public data sources to evaluate all of those exposures.

Quarterly operating expenses decreased by 34% net over fourth quarter 2007. The decrease in operating expenses is due to a 50% reduction in our cash bonus pool for the year. This was partially offset by a higher headcount and rent expense versus fourth quarter 2007.

I would note that we intend to manage our operating expenses very carefully in 2009, and do not expect any meaningful increase over our 2008 run rate. But it is not possible to provide definite guidance for 2009 at this point in time, given the pending acquisition of FSA and the impact of that acquisition on our 2009 financial statements.

Fourth-quarter 2008 net unrealized loss on credit derivatives was $200.5 million after-tax. As we've stated in the past, these mark-to-market changes in our financial guarantees written in credit derivative form are not a reflection of our expectation of economic gains and losses on securities that will ultimately be realized. These contracts are generally held to maturity and the gains and losses will dissipate as transactions approach maturity, absent a credit default.

We believe it is more informative to analyze our results excluding these unrealized gains and losses. As of December 31, 2008, we had net cumulative losses of $386.6 million, or $4.25 a share, for market value related items, such as a net losses on credit derivatives, the fair value gain on Assured Guaranty Corp.'s committed capital securities and accumulated other comprehensive losses on our investment portfolio. Our book value per share excluding this amount is about $25.43, a 1% increase over the last 12 months, while our adjusted book value excluding the $4.25 a share amount is about $41.91, a slight increase from $41.73 at December 31, 2007.

Please note that we plan on filing our 10-K by the close of business today, and that it will contain more details on our 2008 full-year results, audited financial statements and management's discussion and analysis of our results.

I would now like to turn the call over to the operator to poll for questions.

(Operator Instructions) Darin Arita, Deutsche Bank.

Can you give us a sense of where Assured Guaranty Corp's excess capital stands with respect to Fitch and S&P?

Darin, that's a real hard number for me to give you. Obviously, these guys have been changing their severity calculations pretty frequently. Obviously, the last mark we have for both of them go back some time, Fitch back to I think '07 year-end, when we did the final calculation; and S&P, probably late-year 2008, probably September, October, and both times we had excess capital. Obviously, the portfolio has run down a bit since then, but I think they've increased their view of stressed RMBS.

So suffice to say, I can't give you an exact number and I would almost have to rely to the historic numbers, which I don't think are very relevant today.

Okay, that's fair. And with respect to the loss reserve assumptions, can you review what your current assumptions are now on the two Countrywide deals?

We've been looking at that fairly severely. Basically, our assumptions are 100% severity. We continue to basically default most of the current delinquencies, a small haircuts on the current bucket, but everything else pretty much at 100%. And it's really getting down to what is our expectation of who of the current borrowers are going to still default.

If I threw you out some broad numbers, we would show you that in our loss expectation today, we anticipate more defaults than we have already experienced today year-to-date. So if you think about the two deals together -- one was $900 million one was $1.5 billion, $2.4 billion -- today, they have outstanding par of about $1.1 billion. So that means $1.3 billion has left the securitization, about $1 billion in payments and about $300 million in charge-offs. And yet of that remaining $1.1 billion left, our assumptions are about $300 million of that still further defaults.

So we think $300 million of the remaining $1 billion versus $300 million of the original $1.4 billion that has already gone out of the securitization -- or $1.3 billion, rather. So we are taking a more pessimistic view of the future activity than we've already got. And if you really think conceptually is that conservative or not, we believe that those securitizations were hit early on based on a lot of what I will call either small F fraud or big F fraud in terms of the borrower not being qualified to be A, applicable for the loan and be -- and then two, to be put into the securitization.

So if you really said, well, then that should have had the experience by that first half of paydowns to be worse in the second half, our reserving process actually shows it reversed. So I think we've got a reasonably conservative number. That gives you broad strokes of what the assumptions are, without getting down to CD-R's and that type of thing, but just in terms of bulk defaults and the ultimate severities going forward versus what we've experienced to date, if that answers your question.

Darin, also, when we file the 10-K this afternoon and when you go into the footnotes of the 10-K, there is a great deal of detail relative to the assumptions that we've made.

The one other thing I'll add, Darin, since you brought up the HELOCs and this gives me a chance to talk a little bit about those, all of us in the market have really made issues relative to the rest of the warranties of the quality and qualifications of the loans that we are put into these securitizations.

As you know, and we've talked in the past, we've worked very hard through our surveillance group to go back and audit the files. And what we've started to do was audit the files of the charged-off loans, because obviously, that is the easiest one to first look at, the ones you've already in effect incurred a loss for.

What I can tell you today is, as we said a little bit briefly in the comments, is that activity there has picked up. We are starting to achieve a result that I am incredibly pleased by. I think if we continue at this level, it will have a potentially significant impact on the amount of losses we've incurred to date, let alone the ability to absorb any future deterioration in those two structures.

So we are working hard at it. We've got a lot of people. We've got outside assistance. And the results over the last, say, month have been very, very satisfactory to the Company. Although it has been slow, and obviously, you can understand on behalf of the service there, they are not going to go real fast in getting us loan files and sitting down to go through it slug by slug over the qualifications of any given loan in the portfolio, I think we are actually making some really good progress and that progress will be seen as we go through first quarter and continue on through the rest of the year, because we have a lot of files that we need to talk to the servicers about.

On that topic, Dominic, can you give some examples of what you are finding that gives you confidence that your remediation efforts will be successful?

Well, we've done a file-by-file look for the charge-offs, as I said. And if I really try to capsulize it, there are probably 10 common reasons why we don't believe the loan qualifies. And they could be that it exceeds the limit of the loan that is in their own guidelines. It doesn't have some of the required processing take place, like an appraisal, like proof of employment, like additional documentation, like a tax return or other -- verification of the reasonableness of the income claim. It talks about loan to values. It talks about debt to incomes. So there are about 10 reasons.

As we've put these things back, one of the things that's really confused us is there has not been a consistent acceptance on any one given criteria in terms of a put-back; it has kind of been spread over the board. Which we actually think helps us, because if it weren't the fact that it required the proof of employment and there is no proof of employment, yet here is another file where it says there is no proof of employment.

I mean, they are still trying to say they are searching for documentation, as you well can imagine. And if they are both the HELOC and the primary, it could be in the other file and they've just got to trace that thing down. But it really goes along those specific, definable criteria, that really isn't subject to a whole lot of interpretation.

We've hired two outside firms to assist us in this process, so it is not just us making ourselves feel good about the amount of qualifications that we have. And then there is another big caveat that I am just being shown by our head of surveillance that says, most of our deals also exclude any loan where there is any fraud or misrepresentation determined, regardless of when. The loan has to come out of the file.

So as you look at that, we've been, like I said, diligent in it. In the last month, I have to tell you, I think we've made at least some sort of a reasonable breakthrough in getting more activity and more success in the put-back requests. As I said, I think this could have a reasonably -- potentially -- so I'll make sure I caveat the daylights out of it -- significant impact on the level of losses that we've already realized today, let alone any future development.

Okay. Thank you.

Mark Lane, William Blair & Company.

Good morning. My question is just a broad one, directed at the FSA acquisition. You were able to remain profitable on an operating basis this quarter, and the credit environment has definitely deteriorated, but you are saying you think your losses are containable, but there is a lot of moving parts. And you are talking about all these remediation efforts and all these different variables.

But the reality is, you are taking on a company that is twice your size, with a structured finance business that is larger than yours. So how do shareholders get comfortable that you are not taking on an inordinate amount of risk with this deal at this time, given what has happened in the environment the last three or four months?

I think it is a great question, Mark, so let's talk about it a little bit. So I disagree a little bit with the twice your size, even though I think we can lift pretty heavy balances in our Company. But if you look at FSA, I am pleased to say they are pretty much a mirror image of ourselves. We've avoided the really troubled stuff. Both of us were not participants in the CDOs of ABS.

We both have, I think, relative to our capital bases and revenue capabilities, containable RMBS exposure. Their HELOC is five times ours, but once again, they've got a revenue bucket stream that is probably at least 2.5 times ours. So in terms of the ability to absorb, it seems fairly well done.

They have very limited, maybe three times our exposure in the closed-end second. But once again, go back to the capital and revenue analysis. That is fairly well contained. In terms of the pooled corporates, or the structure credit side, I say their book is as solid as our book.

And all the things we've talked about on our call, on our disclosures and dialogue, that book is still very, very, very well performing. And we still do not see any real issues in terms of significance coming out of that book to business, even based on the horrific economic situation that continues to unfold.

Now obviously, the big caveat is if we go into a severe depression, we are all going to be pushing carts around Manhattan selling apples. But at the end of the day, let's assume that the activity of the government and the intervention programs it is enacting are going to somehow stabilize or at least put a floor to where further economic deterioration will go.

But even on that basis, as you know, we are nice enough to give you every statistic on all the deals we've got out there. Go through the website -- those deals are still even today highly, highly, highly protected.

So as I look at their structured book -- and remember, we did the due diligence on every one of those deals. We went through their portfolio, and we have the benefit of being their largest reinsurer, so a lot of familiarity. We know the company. We know the people. We know the underwriting. We've gone through the business. And we are very, very comfortable.

Sure, can there be further deterioration? But there is a huge revenue base there. We've gotten it at a very attractive value in terms of price. I think it really adds to the Company. And because they are a very good complement to or mirror image of us relative to the underwriting discipline, we are very, very pleased with where it is today, what the future holds for it. And then the combining of the two talents of the two companies in terms of the amount of penetration we will have in the various markets is very, very positive from our point of view. And we are excited about closing this transaction and moving forward.

So do you have any insight into their -- not that you would disclose it, but do you have any insight on an ongoing basis in how their business performed in the fourth quarter? Or will you see it when everybody else sees it, and I would assume that is before the shareholder vote?

Well, we get to see more of it, remember, because of the reinsurance relationship. So do we know some of it? Sure we do. Do we know it all? Absolutely not. Obviously, we don't own the company today. We can't affect or intercede or intervene on any of their current business processes.

So our anticipation is -- because we read the same stuff in the industry information -- where they are at relative to new business written, we expect them to take, in proportion to us, kind of the same type of hit across the loss borders. And obviously, we are all sitting here looking at what happens further with the government and the government policies.

And remember, FSA has been put in the situation that it is, all of its financial products business having nothing to do with financial guaranty. So by and large, that is not the straw that broke the camel's back. And as I said, we are very, very comfortable with the company, the management, the underwriting process, the portfolio as it is constructed. And as I said, once you put this together, you are going to see that they very much mirror us or complement us.

Right, and just to reiterate, we are taking no risk on their financial products business.

Just in terms of timing, just so you know, Dexia released their fourth-quarter earnings at 1:00am this morning. So there is extensive disclosures in Dexia's information about their results. And they had preannounced, in fact, that they were going to take all of the closing sale losses on FSA in their fourth-quarter results.

In that earnings release this morning, they indicated that FSA would be releasing their full financial results by March 12, so that would in fact be before our shareholder meeting.

In that -- when you look at that release, though, by the fact that they took a loss on disposition, it's not necessarily reflective -- or you won't be able to take that information and translate that into FSA's results.

Right, okay.

Remember, they've got a fixed sum of consideration they are receiving for the transaction and they know what their carrying costs are. So that is what they are really recognizing.

And that will be compared against their carrying value, because they're going to put the FT business aside.

Got it. Okay. Thank you.

(Operator Instructions) Mike Grasher, Piper Jaffray.

Good morning, everyone. Just to follow up on Mark's question around FSA, Dominic, do you happen to have a feel for what they are doing on the mediation side of things?

Yes, obviously, we have started to bring staffs together, both from the standpoint of integration and potential expense reviews. They are very much in line with us in terms -- and I think that's pretty much the industry, so I'm not giving either of us undue credit for being active in the remediation.

I think we are a little further along, if I can kind of pat ourselves on the back a little bit, because I think we've taken a different tactic in how we've gone kind of file by file. We've gotten commitments to set aside personnel specifically dedicated to our put-back process. As I said, we had kind of a watershed moment in the last few weeks where we actually had a sit-down. We sent back a number of files; they either accept or reject. Obviously, the initial acceptance is a fairly low number, as you would expect. And we had a second round of where we, as part of our set procedures with them, we have a rebuttal process to go back and say, okay, now sit down with us, instead of just sending us back this stuff, and tell us why did this file, you believe, still belong? And we've had tremendous success with that.

And I think a lot of folks are still at the put-back and more or less -- more correspondence rebuttal, as opposed to the face-to-face, let's drag the file into the room, let's get everybody at a conference room table and go through 10 inches of paper, and now let's figure out what this is all about.

Now, it is costly. It is time-consuming. We don't get the immediate gratification that you'd like to see based on the work that we've done. But it is having its success. So they are right in step with us, maybe just a tad behind us.

And we think that is still the better way to go than a lawsuit at this point in time. We are not pleased with the hand-to-hand combat, but we are more than happy to go through the process, because we think it has real potential relative to losses that have already been incurred, as well as to mitigate any further deterioration.

Okay. And then you did mention the acceleration in the Alt-A in the quarter in terms of the incurred losses. Sorry if I missed this, but did you actually comment on what those structures look like -- or how many?

They are in both the supplement and the website. We will tell you that, by and large, they are still -- we do a stressed loss model and then compare it to credit enhancement, and then come out with a factor of enhancement stressed losses. And we still are, by and large, in say about 120%; so enhancements still in excess of stressed losses. But if you look back six months ago, that might have been 140%.

So it continues to get a little warmer. We've only posted portfolio reserves, because remember, in our existing structure -- and as Bob mentioned, it changes as of January 1 in the first-quarter reporting -- as we downgrade something internally -- so you saw the additions to the CMC list of the Alt-A exposures -- that immediately triggers a portfolio reserve. Bob, what is the number that we put up, like 17? $15 million in portfolio.

But at this point in time, we still have enough credit protection, even under a stressed loss off of what we consider the current view of delinquencies, to be able to absorb that.

Now more importantly, or as importantly, there has been a lot of dialogue in Washington about coming out with some sort of a mortgage assistance program. The one that was vetted yesterday, not approved yet, we believe would have a significant impact on further potential losses in our Alt-A and subprime books. So set aside HELOC and closed-end seconds, their second liens, you've got 100% severity, you are basically going to ride that storm as badly as it is. And the only benefit we can see on the horizon there is the reps and warranties.

The first-lien stuff, which is the subprime and the Alt-A, different animal. So if you look at the bill that has been proposed through the Congress yesterday, it had three neat features in it that would really help senior positions in any of these structures. One is that the bankruptcies are not going to be prorated to the structure. They are going to go in at the bottom of the waterfall. That is a big benefit to the senior holders.

Two, they have [lift] off the limit of how many loans could be adjusted. Typically, the servicer has a limited case or percentage of loans, and then it has to start buying them out. So it says now you can leave them in there, which is good, in that typically they are going to go to a market value decline or a set lowering of the interest rate. Either way, if you look at our modeling, we stress the daylights out of these things as we look at these loss coverage models.

So if we say we think there is an average market value decline of 50% and there is another 10% to 15% of cost of foreclosure, we are taking a severity hit of 65% in our model. Now, it is going to get down to what are the market value write-downs that these servicers are going to perform, and they are basically going to look at national statistics on market value declines, which are probably in a 20% to 30% range.

So all of a sudden, for every loan that is reworked, the first thing that happens is you avoid a future delinquency and default. Two, you lower significantly the severity from maybe 60% to 30%. Remember, we take the hit of the full severity when we look at our stressed view of can we have enough collateral or enough vetted protection to cover the ultimate loss. So that is a huge positive.

And number three, the loan stays in the structure, so its cash flow off of the revised principal and interest balance, we still get at the top of the waterfall below the subordinated tranches. So A, it avoids default. It takes us out of the severity hit. And then we get the benefit of the cash flow by having this loan stay in the structure and the amount of the writedown to be less than the stressed levels of severity that we already have built into the models.

Obviously, there is a whole lot of moral hazards that still have to be considered in this situation, and obviously, based on the rules, it is first lien and it's got to be owner-occupied. But long story short, it should help with our view of future defaults coming off of further economic deterioration, as well as limit its severity.

And Mike, just to be clear, the bill that Dominic is referring to is HR 1106, which is expected to be voted on in the House today. It obviously would need to go to the Senate and then through Commerce Committee for ultimate signature. But that is the bill that he is referring to.

So call your congressman and ask him to vote for HR 1106.

All right. But more specifically, though, is it fair to say that there are just two deals that are creating this move in the incurred losses?

Were what -- Alt-A?

Yes.

Yes, I'd say we got the two large securitizations. But remember, they are the ones we've downgraded today. Unless we see some start of stabilization, although the other deals are well protected, because they are not on the CMC list yet, these are the ones that got on there because they are getting closer to getting to a one-to-one stressed losses over coverage. They're the ones that we are concerned about today.

Okay, and one final question, switching gears here. Outside of California, do you have any other states where you might be concerned about concentration issues? Just looking over the list in the supplement, it seems like you probably have adequate amount of room to maneuver.

You are referring to the public finance portfolio?

Exactly.

Mike, obviously California is a big issue. I would hate to say I told you so, but there was a treasurer of that state that was talking about their AAA rating in July of last year. I would hate to think if I made those kind of statements and then wound up in the situation where I might have to file for bankruptcy what you guys would do to me, as well as the general market and the SEC and an Attorney General.

But putting that aside, obviously we look at all the states, not just California, under significant stress. And we've gone back over our portfolio. We looked at are we doing essential type of projects and services? Do they have significant revenue coverage? Because we think there is going to be tremendous stress in the municipal market beyond California. I mean if you just think about New York, the city and the state, and what is going to be the change in income levels, and therefore the tax base, both from the real estate and the income over the next two years, that falloff has got to be hugely significant.

But typically, you are going to wind up having some short-term problems and wind up doing a restructuring and pushing the debt out to wind up getting a recovery. So I think you are going to see a lot more incidence of downgrades and potential defaults, and defaults in the sense of missing or getting a waiver on a principal and interest payment, and a lot of restructuring, which is the benefit of bond insurance.

I mean, we keep talking about the value of our product goes well beyond the fact that you think we just provide a guaranty, and it's about liquidity, it's about valuation, but it's also about remediation. And you are going to see a lot of that play out, we believe, over the next 18 months. But as I said, we are really focusing on kind of the critical services, critical projects and who's got the best revenue protection.

Okay, thanks. That's helpful. Appreciate it.

Brian Meredith, UBS.

Good morning. Most of my questions have been answered. But I guess one, Dominic. If the rating agencies come out and decide that the new entity, FSA-AGO, is no longer a AAA entity; it is a AA-plus entity or whatever, what would be your willingness to go forward with the transaction? Because I know you've got an out clause.

Right, we've got the closing condition that says you can't affect the ratings of AGO. And that is a great question, Brian, and I wish I could give you a sweet answer.

We would have to take a lot of things into consideration. One of them would be what is the impact in the market. Would the market even care at this point in time? How does it affect our new business opportunities and our view of the company in the market? Offsetting that, obviously, is the significant benefit to income that the transaction provides us. We are buying a great revenue stream and I think a really solid company would create intellectual property at a huge discount. So we can not ignore that.

And remember, the out for the downgrade goes both ways. FSA, if FSA gets downgraded; us, AGO gets downgraded. So it is a good question. The things we have to consider is market position, what it does to business opportunity, balance that against about the accretiveness of the transaction. And hopefully, we don't have to deal with that issue, but it's something we would have to consider.

Great. And then just one other one. Just curious with the state of Florida, kind of what your thoughts are there, particularly given -- as a CMC analyst, we know the FHCF and the huge funding shortfall there is there. Kind of how nervous are you about that state?

I guess I'm more nervous about New York and California than I am Florida. And we were actually in Florida last week. There was a municipal bond conference, and I spoke to a number of people from the state. I think they really have a more positive view of their life as they see it than that. And for us, it is not a significant exposure as well. But as I said, I think I feel more comfortable with what I see happening down there than I do with what I think could happen in New York and California.

Thank you.

James Shanahan, Wachovia.

I just had a quick clarifying question here. Regarding the potential change in reserving methodology, do you expect, irrespective of the FSA transaction, would you expect to actually then release reserves back through earnings in the first quarter, or what would be your expectation there?

That's a great question, Jim, because the methodology is reasonably complex relative to anything that is on the CMC list. Things that are, for instance, on our CMC today that are subject to our portfolio reserving process, we actually have to go through a very detailed expected cash flow evaluation of each of those exposures.

So for what is on the CMC list, it will not be exactly as it is today, because the rules are slightly different. There is the possibility -- we are in the middle of that now -- that calculation, there is a possibility that some of it could come back. There is also the possibility that the portfolio reserve would be allocated under the cash flow calculation, so they are CMCs. And it is -- the adjustment anyway goes through equity. It is not through earnings.

And you will remember, Jim, if you think about our portfolio model -- and I don't know if you remember this specifically -- but the whole idea of that was an inherent risk model. We said we know we are going to have a loss; we just don't know where. This gives us a nice mathematical approximation of holding the reserve, so that the financial statements from an income point of view are not overstated. Right? And although it wasn't specific credit, when you ultimately had a loss incurred, you typically had to raise the portfolio. And one of the significant reasons of that is because the portfolio limited the amount of the loss relative to the amount of earned premium realized. Because you are basically in step with your earned premium exposed on that specific deal.

Now that we've got to go to specific identification, the good news is some of those fundamentally sound credits would, as you would say, fall off and you would take the reserve down. However, for the ones that are on the CMC, but are still being calculated in the portfolio, you are now unlocking the limitation of earned premium. So therefore, that increases the potential reserve you can put up there.

So at this point in time, as Bob says, we are going through each and every one of them to figure what the ultimate net effect is. But any positive benefit goes through equity. Obviously, if we just recast the reserve to some of the other portfolio reserve items that are on the CMC, where we unlock the premium limitation, obviously you anticipate then an increase in those reserves.

Okay, thank you.

(Operator Instructions) Eleanor Chan, Aurelius Capital.

Good morning. My question is given that Assured Guaranty is now trading below the range at which Wilbur Ross has agreed to back-stop the equity raise, how does that affect your decision-making as to whether you were going to go to the market and raise the equity or draw on the Wilbur Ross back-stop? And also, is there any room where Mr. Ross might renegotiate the terms of the back-stop?

Well, to the latter part, obviously, the whole idea of the back-stop is you locked in the terms of what would be the kind of lowest value to the stock that we can get in terms of raising the equity to close the transaction. So it is what it is. His floor is $6.00. Dexia's is $8.10.

It is really going to depend on what we hear and see from the market, based on the digesting of this information, as we put together kind of a roadshow type presentation on the value of the FSA transaction integration ultimate impact in the results of the Company and the Company's position in the marketplace, whether that gets the stock price up higher and gives us the opportunity to consider other financing alternatives, is going to be too determined over the next couple of months, as we finish the approval process and then get ready to close the transaction.

Hopefully, we get a better price than what we are currently getting penalized for today in the market. As I look at the Company, this troubles me tremendously, and I can go on my rant. I was hoping somebody would ask me a question to give me a rant opportunity, and you've opened the door. But here we are, a company through the worst economic times where you can see exactly where our exposure is. There are two really positive things that are happening that will further limit that -- the potential bill coming out of the Congress, as well as now the implied success we are seeing in the reps and warranties. That really then takes us out of what I think is really a horrific circumstance.

If you look at the rest of the portfolio, we give you all the detail. It performed well. We are the only company that has been able to maintain operating income throughout the worst period in anyone's recollection. Yet we are being treated as if we are one of the companies that is ready to require government assistance or file for further protections, et cetera. I mean, it just boggles my mind as we sit here and look at -- and it's not like we are not transparent. We are not trying to help you guys along to say, look at everything we possibly have and ask us any questions you want.

And then we get this tremendously accretive transaction that says, okay, we are buying a whole lot of economic value for not a whole lot of money, and the company is pretty much like us. We are all tipped to its exposures and yet we are being treated by like a penny stock. It absolutely blows my mind.

And I don't know what the value of all the work we are doing, because is not reflected in the share price, that's for darn sure. So hopefully, some reality hits the world, the price moves up and we get to actually keep this transaction and a lot of favorable terms. But the nice thing is we don't have the downside. The downside is already in, contracted, structured and able to close at a still very highly accretive value to the Company.

Okay, great. Thank you.

Jay Leopold, Legg Mason.

Good morning. I just wanted to go back to the loss of reps, warranties and reps on the Countrywide. You've gone through some files and exchanged views. Have you actually settled on any single loan remediation yet, or are you still.....?

Sure, sure. We've actually -- if you go to -- I don't know whether it is in the supplement or the website -- we are actually starting to show the breakdown of rep and warranty recoveries as part of the deal performance. So you are going to be able to start tracking that every month. We've already received, I want to say -- okay, here's the number, $16.5 million. And that is up from, if you went back two months ago, like $8 million.

We've gotten -- like I said, that process is actually starting to work, it is showing benefit. Like I said, we've put a tremendous amount of time. We started this back midyear last year. And if you talk to our surveillance people, I think they are ready to hang me from as much questions I ask them and going through and making sure that we are staying on top of this.

Plus remember, this affects every deal. So we could talk about Countrywide as being probably the poster boys for the activity done today. But it juggles through the closed-end second deals as well, and we've begun pulling those files and doing the same type of rep and warranty type of review.

So yes, we've actually collected real money. We've got commitments for more. We now have a process in terms of the rebuttal, and you sit down and actually go through the file with everyone in the same room, which we are seeing as providing good benefits to us.

So when you are going through a specific file, is it black-and-white that, yes, there is an issue here in some cases and others you negotiate for $0.50 on the --?

Remember, we always think everything is black and white. We wouldn't have put it back -- because remember, we've gone through two levels of external vetting. We are not sitting here trying to say, this is great; let's see if we can get some value, and let's see if we can say, okay, we disagree; just give us 50% of it. This is 100%, and you accept it or you don't.

And even the ones you don't accept at the first level, we rebut. Even the second one. When we got to this last second round, we said even the ones that still fell out, we are still holding aside. Because we still believe it is as black-and-white as the other ones that you've already accepted.

Remember, these things are pretty definable. One of my responsibilities -- because Mr. Mills and I signed some financial statements that leave us out with a little bit of exposure here -- is to make sure that we had a very detailed, specific and heavily-reviewed process, that it was specific to absolute identifiable situations. So we are not into the old, we are going to throw a ton of stuff against the wall and let's see if we can get you to accept 50% of it. That is not what we are doing here.

So we don't have this, well, we put up a big number so that you come back and give us 25% of it and we are going to go back and high five in a closet that the 25% was a good number. Wrong answer. So we actually sat down, and it is 100% of every file that we reject, they reimburse back the loss, and that they accept. So we are in that process now.

So you were getting 100 cents on the dollar on the ones you are agreeing to?

Yes.

Okay. And in an example of the 16.5 so far that you've gotten, are you netting that against your $300 million of charge-offs so far?

Remember, I said we had $300 million in charge-offs. We anticipate another $300 million, about $600 million. In our reserve calculation, we are taking about -- round numbers -- a $50 million credit on the ultimate $600 million in charge-offs.

And now today, we are at 16, but that is on such a small segment of that ultimate $600 million in charge-offs that quite honestly, we would have to -- if we continue this level -- as you have to remember -- this has really happened over the last couple of weeks -- we would have to take a hard look at the -- I think it is $49 million, not $50 million. But whatever the number is, we would have to take a hard look at that estimate as well.

Because obviously, we know that other folks in our industry have put up bigger numbers relative to the ultimate credit for this type of remediation or recovery. We've been trying to take it kind of as we go and generate based off of success that we see and we can actually prove. I mean, your questions are very well targeted.

One of the things, though, to be honest with you, we think part of the deal here is, as we go back and fight the battle file by file, that the other party -- you are going to say, okay, we are spending a ton of time; these guys are winning; let's make a global settlement. And then it will come down to are we amenable to a settlement? If so, what would we accept as a settlement and how would that affect our loss that we book today, as well as any exposure to future losses?

These are great questions that we have to consider and what we are working towards, even though we are more than happy to fight file by file and go and sit there and get the 100% recoveries, as we are doing on a file by file basis.

So just to confirm what I think I was hearing you say, you have kind of have a contra-reserve of $50 million out of this $600 million total.

I'm sorry -- against that $600 million, you also get the benefit of excess spread. You get the benefit of future draw because of the way those two deals are structured once you hit the rapid am trigger.

So there are three positives -- spread, draw and rep and warranty; negative being defaults and severity. So it is the battle of who wins out, and in that calculation that get us to the current reserves held, you basically start with the $600 million, you get the credit for the spread and the draws and the put-backs. The put-back credit is rough numbers $50 million.

Right. And that number could grow significantly if you keep having success?

Exactly. The percentage of success on the last files would indicate that that number would be significantly short. So either way, if we continue to maintain that -- so, no promises, no guarantees; I don't want to have Sabra come and beat me over the head and say, wait a minute, you said too much of a positive nature. It will either do one of two things, limit the loss you've already realized or stop any further deterioration.

Got it. And then on the Alt-A side that is coming around the corner, is it tougher to go file by file because a lot of Alt-As by definition are maybe low doc or no doc?

Yes, but they have say -- typically, the Alt-A has something that is missing. But that means all the other stuff is there. So you still go back and do the file by file on making sure that the stuff that should have been there. So if it is an appraisal issue, fine, you set aside the appraisal. But the proof of income, the asset value, the debt to income still has to be there.

Would you characterize the Alt-A is going to be tougher to win?

I can't tell you that, because we haven't really begun that process. And understand, we got it conditional as I need it to be conditional. We have done the work. We've gotten more positive success recently. What it could possibly lead to is what I said. The possibilities are out there that we would have to relook at the credit that we take or does it lead to a settlement. Those are the open questions. But it reflects against anything in our residential portfolio relative to the reps and warranties that are contained in all Alt-A deals.

Okay.

And remember, the Alt-A and the subprime would be even better benefited by the passing of HR 1106.

Great. Thank you.

Tim Bond, JPMorgan Asset Management.

Thank you. Good morning. I had a couple questions, if you could just kind of step me through some of the cash flow dynamics behind the business. The cash that went out the door during the quarter, is that the claims paid of $90 million or is that the incurred losses of $114 million during the quarter?

Claims paid.

Okay. And then the cash flow coming in, is that the earned premiums plus the interest float?

It is gross written premiums plus the interest income.

Okay.

Because remember, when you do the municipal deal, you get the cash up front. That is why it is gross written, not earned. The earned just says in the portfolio, I have collected premiums in the past, and this is the percentage that I can earn in the current period off of the runoff of the exposure. Cash is really off of gross, which is really the receipt of further payments on the installment business.

Okay, so in a pretty harsh quarter, then, you were able to cover any kind of cash outlays then with basically operating cash, correct?

That's exactly right. There was positive cash flow for the quarter, and the net premiums written were over $114 million. Then you have investment income of $46 million. So you had 161 inflow, which more than covered the losses paid during the quarter.

Okay. And then the 2008 incurred losses, then, were $309 million. And then you've got the loss adjustment expense reserves that fall. I would expect, given that kind of outlook, that the claims paid should fall during 2009 each quarter. Would that be a correct assumption?

No, you can't go there, because now you are using claims paid as opposed -- you said incurred, or maybe you meant paid. But the claim payments are going to be based on what continues to happen in the residential securitizations and whether we pay any further legal expenses on some of the other things, like say Jefferson County.

Okay, I'm sorry.

They are a hard number for us to predict, but obviously, your point that you've made at the beginning, we have enough operating cash flow that seems to meet those needs even at the high levels of paid losses. The one thing we could tell you is if you look at the HELOC, the '05 deal is at least stabilized. So there is actually a decrease month to month now of what the claim payments are. But on a percentage of the remaining PAR, there is still a high percentage, but they are coming down.

If you looked at the operating cash flow for the year, even in the situation that we are in, it was very significant. There is about $400 million worth of operating cash flow, even considering the losses paid. And that is operating cash flow, not from additional capital.

Okay. It just seems with the lack of CDO, especially mortgage-related CDO obligations and the lack of any type of payments down the road on that, and the fact that you are generating operating cash flow, then there is a decent chance you will be able to cover any claims paid with that during 2009. It kind of points to the fact that while you've got investment assets sitting there of what -- is 2 point -- no, it would be around what -- 3.6?

3.6.

So 3.6. So the market cap of the Company is $500 million, but yet you've got three point some billion dollars of just investment assets that are sitting there. It seems like there is a relatively big discount.

You are making my case for me. Thank you very much.

I mean, you know, you have unearned premium reserves that are going to spin around and produce income, plus the cash that comes in from the installment premiums of cash flow. It is hard to predict what losses paid are going to be, but the cash flow coming in will continue to be robust.

Do the rating agencies ever talk about the position these type of cash flow dynamics, or are they more concentrated on kind of the modeling out of future losses and look at things kind of traditionally?

Certainly there is a view towards liquidity. There is no doubt about that.

Liquidity from the standpoint of termination events, collateral posting, some of the issues that have happened in the past. They still have a view towards operating capability. Are you writing business, do you maintain profitability, are you positive cash flow?

But, obviously, they are more of a capital orientation, so they are obviously looking at stressed losses, total potential in the portfolio, what's the level of capital against it. So there is a balance; I'd say it's still more weighted to the capital than it is to the operations.

Thank you.

Patrick Dennis, DK Partners.

Good morning, guys. Thanks for taking the call. One quick question about the separation of exposures. As we know, MBIA has gone on the road of isolating out the US muni business or reinsurance contracts. Once FSA is under the umbrella of Assured Guaranty, is there any intention to also separate out the US muni exposure to one of the two insurance entities?

Well, let's speak of it in a different context. What they're really doing is setting up a pure-play muni-only company. They think that would be very well accepted in the market.

First and foremost, our Company as it is very well accepted in the market. As we talked about through last Friday, we did 12.7% of all municipal issuance. That is an incredibly positive statistic. So we already have tremendous market acceptance. The reason why they are doing that is to get market acceptance, because they've got to separate. And strategy or plus or minus, that is the position they proceeded on.

Closing the transaction, and how we look at licenses and business platforms, will give us the option of putting a muni-only company into the market, if we deem that that is a good avenue for us to pursue. So that's an open issue. The transaction helps us along that way. We have strategies in place that we could get a pure-play muni company out there, to the extent we deem that to be beneficial. But let's not lose sight of the fact so far in the quarter, or year to date statistics that are public, we have written more percentage of the market than ever in our history, and probably pretty comparable to even when the market was dominated by other players, what their percentage of the overall issued market was at the time.

Okay, great. Thanks.

At this time, we are showing no more further questions available. Sabra Purtill, you may proceed.

Thank you, Josh. Many thanks to you all for joining us today, and we certainly appreciate your interest in Assured Guaranty. If you have any other additional questions or require further information, please feel free to contact me or Ross Aron by e-mail or by telephone, and we look forward to talking to you again soon. Thanks, and have a good day.

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