Assured Guaranty Ltd (AGO) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2009 Assured Guaranty earnings conference call. I'll 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 today's conference. (Operator Instructions)

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

Thank you, and thank you all for joining us today for Assured Guaranty's second-quarter 2009 earnings conference call. Our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Limited, and Bob Mills, Chief Financial Officer. We will take questions from the audience after their presentations. Please note that our call is not web enabled for Q&A. If you would like to ask a question, please dial our conference call organizer at 1-800-299-7098 and join the call live.

I would like to remind you that management's responses or responses to questions today may contain forward-looking statements such as statements relating to our business outlook, market conditions, credit spreads, ratings, loss reserves, acquisitions 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 and for more information on factors that could affect our future financial results and forward-looking statement. I'll now turn the call over to Dominic.

Thank you, Sabra, and thanks to all of you on the call for your interest and support of Assured Guaranty. In the second quarter of 2009, we continued to proceed with the integration of FSA and Assured based on the anticipated closing of the acquisition which was completed on July 1. This acquisition is highly capital accretive and further advances Assured as the market leader for financial guaranty insurance.

In regard to our second quarter result or origination activity and the direct municipal business confirms the continued demand for our financial guaranty product in this challenging market. While the present value of premiums declined from those of the same period in 2008 the approximate $128 million of PVP was slightly ahead of a the first quarter of 2009 which we view as a more apt comparison based on current market conditions. Furthermore, we are off it a strong start in July, which I will discuss later.

Also in the second quarter, we did record additional losses and loss adjustment expenses primarily in the Alt A and option arm portfolios due to increase delinquencies which impact our reserve model. For example, 60-plus day delinquencies in our direct Alt A portfolios increased from 23.5% to 25.8% from the first to the second quarter. For option arms, the 60-plus day delinquencies increased from 25.5% to 28% over the same period. The increase in delinquencies leads us to assume a longer period of elevated losses requiring us to add to reserves.

It will take some time to get certainty on the performance of the RMBS portfolio. However, our exposures continue to amortize and therefore reduce the probability of losses that are not manageable in the context of our overall earnings model. Second-quarter operating earnings excluding cost of acquire FSA holdings were $42.9 million, an 11% increase over the prior year's periods. Bob will provide further details on the financial performance later.

Turning to the acquisition of FSA, we are now well positioned in this environment and are energized by the potential of building market leadership through the larger footprint and stronger capital structure of the Assured-FSA combination. In that regard, we have made a number of strategic decisions to build on the franchise value of our enterprise and optimize our business opportunities. First, we will operate Assured Guaranty Corp. and FSA as two distinct and separately capitalized direct financial guarantee platforms. FSA will be a public finance only insurer and Assured will write both public finance and structured finance business. In the structured finance area, Assured will underwrite subject to our tighter standards and lower limits reflecting our current view of this business and the new economic reality regarding risk and performance.

Second, Assured Guaranty Re as a reinsurer will provide capital support and risk management to Assured and FSA and will create further business opportunities for the Company based on its capabilities to write credit default swaps backed by its capital base. As a result of the combination, we now have a unique selling proposition based on our ability to offer issuers and investors the flexibility and capital strength of two distinct and separately capitalized platforms. In the US municipal and public infrastructure markets, where both Assured and FSA participate, we will offer our guarantees at one price and apply the same conservative underwriting standards across both companies. Operationally the platforms will be fully integrated for origination, risk management, and surveillance, credit, financial reporting, and technology, and we are well on the way toward completing this integration.

In addition to creating maximum operating efficiencies, the new structure will provide us with greater capacity to write business for large frequent issuers and on larger transactions. And we will have increased flexibility in balancing our portfolio exposures between the three companies. Since July, we have been actively taking this message out to our customers and have gotten positive feedback both on the benefits of having two names in the market to provide greater diversification and the strong perceived strategic value of a municipal-only insurer for certain issuers and investors. Additionally, these interactions with underwriters and broker-dealers have underscored their belief in the bond insurance value proposition. They readily offer that bond insurance helps them distribute securities, provides finance savings, market access and surveillance, particularly for more complex and well -- and less well-known issuers. And particularly assist in maintaining supply and demand at the retail level.

With respect to the integration of our credit and risk management functions, we have retained a significant number of managers from both companies and have constructed the best in class of underwriting, risk management, surveillance and loss mitigation personnel to assure investors of the highest quality of Assured product.

Some additional notes regarding the market attractiveness of our FSA franchise. First, FSAs existing Assured portfolio will rapidly evolve toward its new focus of public finance only as almost half of its current structure finish exposure will run off by year end 2011. Reducing the outstanding amount related to structure finance to $57 billion changing its portfolio composition to 83% public finance, and that's if we were to write no new public finance business between now and then. Second, the FSA financial product business, primarily (inaudible) was not part of the Assured purchase and our subsidiaries are full indemnified against exposures to this business by Dexia with support from the French and Belgian governments.

Lastly and most importantly the combination of two companies results in a significant increase in our future earnings power. As of June 30, Assured had $3.3 billion of net future premiums in force and FSA has $3.1 billion which will be further enhanced by purchase accounting adjustments in the third quarter. Additionally, Assured and FSA have combined the investment assets of approximately $10 billion which would generate significant additional income.

Looking at our current market performance and opportunities in the month of July, we originated $3.3 billion of municipal bonds across the Assured and Fsa platforms for a 12.9% share of new issue public finance volume. Assured's July penetration was one of the highest this year, rebounding strongly from that of June. We would expect to see a significant increase in Fsa's activity as a rollout of the two platforms proceeds.

While new business generation in the structured finance market remains dormant, we are seeing inquiry in secondary market transactions where we can help investors with risk management as well as capital optimization. Additionally, in the international markets, we are seeing some opportunities to provide secondary guarantees on portfolios. Again, as we look at these new opportunities, we are constantly analyzing the potential impact of the current economic environment on each sector and in conformance with our revised aggregate and single risk limits and underwriting guidelines.

Turning to the rating agencies, we are extremely concerned about the challenges posed by the continuing changes to the rating agencies assumptions for the performance of residential exposures and corporate risks in our portfolio. While we are committed to achieving the highest ratings available, we also believe that the uniqueness of the financial guaranty product and our impact on the capital markets requires that we be included in a comprehensive, consistent, and transparent regulatory environment. With that in mind, our industry would greatly benefit from a single capital model that is transparent, consistent, and sustainable similar to the fed's recent stress test for banks. We continue to talk with treasury and others on the Hill, and in June we testified before congressman Kanjorski's sub committee on capital markets, insurance and government sponsored enterprises supporting federal regulation. We're also encouraged by congressman Frank's proposal for a federal reinsurance program for qualified municipal bond insurers and for the Administration's call for greater transparency of assumptions and stress tests by the rating agencies.

Before turning the call over to Bob Mills to discuss financial results in more detail, I want to re-emphasize my enthusiasm for this new chapter in our history. I believe the Assured and Fsa platforms which represent the two entities that have not obligated to the best in the rough economic quarters will lead the monoline industry back and continue to create value for our bondholders and shareholders in our enterprise. Bob?

Thanks, Dominic, and good morning. I'd like to cover some brief highlights of the quarter and then we'll open up the call for questions. I'd like to remind you that this quarter's results do not include the Fsa acquisition which closed on July 1, 2009, but do include the effect on book value per share of the equity offering we closed on June 24.

We expect to file our 10-Q on Monday, August 10. Our second-quarter 2009 operating income excluding $24.2 million of pretax expenses directly attributable to the acquisition of Fsa was $42.9 million or $0.46 per diluted share. Up 11% over second-quarter 2008 operating income of $38.7 million or $0.42 per diluted share. During our equity offering we indicated that we expected Fsa acquisition-related expenses of at least $19 million for the quarter, the bulk of which were associated with subletting duplicate New York office space. We expect to incur an additional Fsa acquisition relate expense of approximately $60 million over the next three quarters. The majority of this expense will be related to severance, although there will be expenses related to systems and process integration, as well as office consolidations of locations other than New York.

We will continue to provide with a breakout of those expenses from our normal operating expenses so that you can see both the level of those expenses as well as the improvement in our expense efficiencies as we finish the integration of Fsa into Assured which we have targeted to complete by the end of March, 2010. Stockholders' equity per share was $17.52 at June 30, 2009, and our adjusted book value per share was $31.75. Both shareholders equity and adjusted book value per share include the cumulative unrealized mark-to-market lose on our contracts written in credit derivative form as well as on our investment portfolio and our submitted capital securities. Excluding these items, our book value per share was $21.56, and our adjusted book value per share was $35.79.

The reduction in book value and adjusted book value per share for March 31, 2009, was due almost entirely to the issuance on June 24, 2009, of 44.3 million shares and the equity offering to pay the $546 million cash portion of the Fsa acquisition on July 1. We issued an additional 22.3 million shares on July one to Dexia for the stock portion of the acquisition which will have a dilutive effect on book value for the third quarter 2009. Although we expect substantial earnings decretion from the Fsa acquisition.

Our new business production which we measure as PVP or present value of gross written premiums for insurance and credit derivatives totaled $140 million for the quarter, down 50% compared to $278.9 million for the second quarter 2008. But above the guidance of $130 million that we gave in June during our equity offering. Our direct public finance segment continued to make headway, ensuring 7.6% of US new issued deals that were priced through the quarter. Our pricing levels are consistent with the prior year's quarter after accounting for business mix between the quarters, and we continue to be able to achieve our target returns in this environment.

New issue activity remains weak in direct structured finance and international due to market conditions as well as our continued stringent underwriting and pricing standards. There was no new business in the reinsurance segment in the quarter. We have, however, seen some attractive secondary opportunity on the structured finance side as of late, and we continue to work on portfolio transactions for the reinsurance business.

Turning to the income statement, our net earned premiums were up 52% over second-quarter 2000, in part du toe refundings on the reinsurance book which totaled $20.1 million. $0.14 per diluted share versus $2.1 million or $0.01 per diluted share in the second quarter 2008. While we cannot predict or project the level of future refundings, it appears that we may see continued high levels of refinancing some transactions that have been insured by run-off and downgraded monolines.

Net investment income was $43.3 million in the quarter, up 8% from the prior year due to higher levels of average invested assets as our pretax book investment yield was 4.3% in the quarter, down from the prior year due to market interest rate. The FSA acquisition will add substantially to our investment portfolio, and we're currently evaluating the composition and management of our combined $10 billion investment portfolio. We expect the overall credit quality of the portfolio to remain high. Currently the combined portfolio has an average rating of AA.

Loss and loss adjustment expenses including incurred losses on credit derivatives totaled $73.2 million in the quarter compared to $43.7 million in loss and loss adjustment expenses and incurred losses on CDS in the second quarter of 2008. The majority of our loss expenses in both quarters and since the end of 2007 have been due to poor delinquency, severity, and loss trends on RMBS exposures.

During this quarter we increased our loss estimates for first lean US RMBS mortgage exposures, primarily Alt A and option arms which included additional refinement of our Royal Rate methodology and increased loss severity assumptions reflecting the most recent data on foreclosures and market prices. Our below investment grade list rose to $10.1 billion at June 30, 2009, about 4.1% of our net par outstanding. The highest level we've seen since the IPO. The downgrades were largely in the structured finance sector, particularly in US RMBS.

Although we incurred additional loss expenses of $46.4 million on second lien exposures in both the direct and reinsurance segments in the quarter, we had no material additional loss expense for the two Countrywide HELOC transactions in our direct segment. Additionally, during the quarter we recorded a $20 million benefit from a previously established litigation reserve for a disputed mortgage guarantee reinsurance contract which has now been settled. You can find the details of our second-quarter 2009 loss reserves on page 40 of our financial supplement.

Other operating expenses were $22.6 million in the quarter, up 15% from the prior year. The increase in expenses was largely related to a lower level of operating expense deferrals due to decreases in new business activity and originations in the structured finance and international sectors. Employee-related expenses were actually down slightly compared to the prior year.

I'd now like to briefly discuss Fsa's financial results before taking your questions. Fsa will no longer file a 10-Q. However, for the benefit of investors and Fsa rep securities we will continue to file financial supplements for Financial Security Assurance, Inc. Which will be updated to be consistent with the types of disclosures we make for Assured Guaranty Corp. Fsa's financial supplement will be available on our website and 8-K on Monday, August 10. In the meantime we would like you to know that Financial Security Assurance, Inc. had operating income adjusted to include holding company debt expense which we are assuming in the acquisition of approximately $110 million from the second quarter of 2009 compared to an operating loss of approximately $450 million in the second quarter of 2008. Comparable net income for the second quarter of 2009 was about $207 million versus a net loss of approximately $240 million in the prior year's quarter.

Loss and loss adjustment expenses on financial guaranty contracts and credit derivatives were about $121 million? Substantially less than the $884 million that Fsa recorded in second quarter 2008. Shareholders' equity was approximately $2.9 billion at June 30, 2009. Please remember that the application of purchase accounting to the Fsa acquisition will have a material impact on our income statement and balance sheet for the third quarter 2009 and going forward. As a result, our future income statement and balance sheets will be substantially different and larger than what they are today. The pro formas that we provided in June during the road show gives a good indication of the changes, although the actual items will be based on July 1, 2009, valuations. However, because of the magnitude of the purchase GAAP impact, we're not currently able to provide guidance on the third quarter 2009 net earned premiums, operating expenses, tax rates and other items that we have previously given you on.

Our third quarter 2009 results and balance sheet will provide a baseline from which we can once again provide you with some direction on unearned premium reserved rollouts, expenses, tax rates, and other items that are materially impacted by this peak out. We appreciate your patience with us on this, and I want to assure you that we remain absolutely convinced that the acquisition of Fsa will provide us with substantial earnings and ROE accretion, and we look forward to achieving the benefits of this acquisition in the newar future. With that I'd like to turn the call over to the operator to poll for questions.

(Operator Instructions) Your first question comes from the line of Mike Grasher with Piper Jaffray.

Good morning, everyone.

Good morning, Mike.

Dominic, I mean, you went over the -- some of the various changes in delinquencies rates and that. Seems to me that it looks like modest deterioration at best. And in your opinion, do you think that the worst may be behind you already in terms of your own portfolio?

Mike, that's a hard question to answer as you can well appreciate. I'd probably be shot if I answered it anyway. If you look at the numbers, it really is difficult to predict when you think about it -- one of the things we track is the 30 to 59 bucket because that obviously would feed future delinquencies and defaults. And that bucket has pretty much consistently come down across most of our exposures. So from that perspective, you can say, jeez, things look like they could be at least bottoming if not getting better. But you can't forecast ultimate activity on a month.

The second problem we have -- and this is difficulty throughout the industry and throughout all of our exposures, if you think about where activity's been and you're looking at the '06 or '07 exposures principally or the '06, '07 originations, since we know that, to use a more polite term, misrepresentations of the borrowers are insignificantly influencing delinquency and default activity, you would also, then, if you think about it from an actuarial concept that most of those losses should be front end loaded, meaning that they would arise in the early part of the experience of the securitizations. And how we try to account and adjust for that and then what that would mean further for the continued performance of delinquencies is probably the toughest thing we have to really make the conclusion that, you could appear to start to look at from the standpoint of performance.

The third thing is as you look at servicers now being given a rather strong direction to start to pay more attention to loan modifications, that would also then build up the plus-60-day delinquencies as those loans hopefully could be part of this repair process that is being definitely pushed by Washington. And we think especially in the first lien arena have pretty strong impact. Nationally numbers appear to be at least flattening out. We see that across almost all of the securitizations. It's still too early to call. There's some positive things out there when we adjust for what we call misrepresented loans or borrowers in the structures. Thirdly, the government programs to really look at loan modifications, if you look at that data on a month-to-month basis, it significantly increased in the last month which might tend to indicate that the instructions to the servicers and to the banks is going out, that they should work harder at modifying more loans.

I'm more optimistic than I would have been three months ago, but I'm not willing to call the end of the day and as reflected in our quarter our reserve models are incredibly sensitive to even a 1% or 2% change in those numbers. We've got to be consistent in how we apply our rationale to how we book reserves and we'll follow that along and hopefully someday we'll be taking down those reserves because maybe that misrepresented element will be a factor that will drop that rate and maybe the rework program will be a factor. Remember, in the first lien stuff, we have yet to start to address what those misrepresented loans would be in terms of further recoveries in terms of reps and warranties. Just to handle that question.

As we look at the current market, because we're paying losses on the seconds, both close end seconds and HELOCs obviously that's been the predominant part of our focus relative to our auditing of those files and our claims for rep and warranty recoveries. We think that will take us through the rest of 2009. Since we don't anticipate paying losses on the first lien stuff, for a while that will give us time in 2010 to focus on the first lien and looking at what our rights are going to be under the rep and warranty provisions of those contracts. That will start to adjust those reserves probably in 2010 if we find the same level of issues we have with the second lien exposures that we do have. Long answer to a short question. I apologize. But I think it lays it all out here for you.

Okay. But in your -- as you look at the 30 to 59-day bucket, is it your -- do you suspect that loan mods have played any role at all to this point?

I don't think they have. We're (inaudible) -- I think I saw something, and we read so much stuff on this, you can well imagine. I can't remember the source. But the number in the last month was significantly higher by a multiple of the previous month. And there was some place that published -- that actually buy mortgage originator and the numbers are till incredibly low relative to the percentage of defaults or delinquencies rather.

Okay. So all that being said, which exposures maybe have you most concerned at this point? Seems to me the HELOCs have kind of stabilized in here. That was a big concern some time ago, but that seems to have fallen off. Where do we look to now I guess?

Obviously where we look to today is option arms and Alt A where we've got significant exposure. This quarter we recognized reasonably significant reserves based on this kick-up of delinquencies rates. As I said, that's where we've done the least work in terms of reps, warranties, and that kind of stuff. That's the area that has big exposure, has continuing deteriorating performance. But it's also the area that we think we could have the most impact from the standpoint of reps and warranties and, more importantly, can have the most benefit from loan modification programs.

Okay. Final question, then I'll jump back in the queue. Can you talk about your capital position sort of the at the end of -- 50%, the numbers running off the Fsa book at the end of 2011. If the structured market remains fairly frozen by then, what's your capital cushion going to look like or can you estimate that for us?

Mike, that really would depend on whose do you want to talk about. Obviously we have one view from say, S&P as a rating agency. We have another view obviously from Fitch and another view from Moody's. All we can tell you is the structured finance portfolio for the Fsa part of the Company runs off significantly. And although we do see structured finance and we do see it as a critical element, by the way, of the economy, we do see it returning but more to traditional asset classes, traditional structures. So the business volume will never be what it was, and the business that you will write will be fairly vanilla, very high attachment, very granular collateral. So even if that exposure that you put on you wouldn't expect it to have a huge capital component. So by and large, with the level of writing today even in the municipal market, you're going to see a continued run-off of both portfolios, of reasonably significant proportions which really should then create continued excess capital which would hopefully offset any further needs that maybe the rating agencies might determine but also put us in a position to say, okay, what do we do with excess capital if we really define that the market opportunity's different, the size of the potential marketplace is different and we'll come to that decision and be very public in the discussion of it.

Okay. Thanks.

Thank you.

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

Good morning.

Good morning.

May I get a further update on the remediation process with the second lien mortgage exposures? I guess in particular I'm sort of curious, the number of loans that have been reviewed thus far out of the total pool of defaulted mortgages. And -- and what percent are generating breaches of reps and warranties?

As we've talked in previous times, Darin, we try to go through the pools as best we can. To give you the two HELOCs which we're most familiar with, for the sake of argument if we look at the total -- the total of two HELOC deals for Assured Guaranty against our favorite originator Countrywide, we've looked at about 90% of the charge-back loans. On that basis we've requested refunding for 85% of those loans. For the loans that we actually go completely through the review process. Meaning that we send the letter, a given amount is accepted, the remainders go into a kind of further reviewed file. We then sit down and go file by file on those further reviewed file. We get through the entire process, so when a loan was in the original batch as it worked its way through, including the file-by-file review, we're averaging in the 70% range of accepted recovery on the rep and warranty side.

And that's where we've done substantially the majority of our work as you can appreciate we've spent literally hundreds of millions of dollars in reimbursing these charged-off loans. We are now starting that same process because this is very tedious work. And although you can hire 1,000 people to do 1,000 man hours of work an hour, that's not going to be very effective. And in our process we do use an outside service as also part of this loan file review. It's just not our folks coming up with their decision, we independently confirmed it with an outside provider. So it takes a lot of time. So it's very tedious. We've paid more attention to the HELOCs. We're moving into the closed end second and beginning some very preliminary work on the first lien stuff and typically in the option arms and the Alt A's. We're trying to get the second lien stuff done first as I said in the earlier comment. We hope to get that through through 2009. We're obviously going back to the originators and trying to get commitments for a quicker review process because obviously this is cash out for us. And I'm not in the mood to lend large banks money. So we're going to continue to push this as hard as we can.

And what was the amount of recoveries that were booked this quarter?

Jeez. Quarter over quarter is probably in the 10 million to $15 million range if I had to guess total. As of the end of this quarter, we're up to $30 million, almost $31 million in recoveries.

Just trying to get a sense of, what -- what is that based on? Is that based on what you've actually collected, or--?

That's based on what we actually collected. Obviously we have a tremendous amount of files pending reimbursement or pending final review.

Right. Based on the numbers, it sounds like you would expect to collect a lot more than this.

Obviously.

Okay. Looking at the public finance business for Assured Guaranty and Fsa, you mentioned that they would both compete on the same price, but can you talk a little bit more about how this -- how both entities would operate as you pursue business? Will you have separate stuff, meeting with the issuers and the underwriters, or can you talk about how this would work.

Sure. Now as I said in the brief opening comments, we offer a single price and really allow the issuer and the investor to choose which platform they want. And we think that's the fairest method currently so that we're not trying to point people in one direction or the other. That single price is predicated based on a single underwriting process, a single credit process. And all the infrastructure supporting it is all combined. There is no separate staff for one, separate staff for the other. It all comes to a common infrastructure.

We think as the market develops obviously there will become preferences from one buyer to another and one issuer to another. Our goal is to keep the same price out there relative to both and, therefore, allow the business to get to better penetration levels. And then the unique thing that we have is because it's all one family we've -- the internal side, we will be able to from an internal reinsurance point of view balance all the portfolios so that the risk rating is right, the capital optimization is right as we look at Assured Guaranty Corp. and Assured Guaranty Re as to what they'll ultimately have. Remember the Assured Guaranty Corp. will be the only one that will write direct structure business in financial guaranty form.

So its book would have to be looked at from the standpoint of business. If we see a disproportionate amount of public finance business, say going into our Fsa platform. We think we're in a very unique position. We wanted to keep both capital bases out there. Because, as we said, large issuers, we want to make sure we have significant capacity and we can continue to service the market regardless of the size and the frequency of the issuer and this kind of gives us that capability.

Thank you.

You're welcome.

Your next question is a follow up question from the line of Mike Grasher with Piper Jaffray.

Okay.

Back again, Mike.

We charge you for the second one, Mike, just so you know.

All right. Want to go back to my question around capital. You make a good point in terms of which one are you talking about. And I guess you had some comments around Washington, encouraged by the developments there. Can you elaborate a little bit more on specifics as to maybe where they are headed in terms of a single regulator or not, and what that might entail.

Well, I think they're discussing it. I think it's not the first item when they come back from recess. So, if there's going to be any movement, I guess it's going to be sometime next year. Maybe early, maybe mid. But there seems to be, after they think they've gotten the right fixes and that's still an open question, and everyone's looking for more confirmation, just like you are for the losses in our mortgage pools, that's first and foremost on everyone's mind. And obviously tying up the majority of all activity. But now you're starting to see them talk about how do we change regulation. They're talking about the insurance world. We keep trying to make sure they understand that, although you call us insurance, we're more akin to banking and capital markets. And obviously have significant effect in those areas more than, say, a property, casualty or life insurer. So the insurance part of our name should be secondary. The financial indication should be primary. Therefore, we need a comprehensive regulatory regime. The fact that you ask a good capital question and I feel embarrassed that I can't give you an answer. Why can't I give you an answer, because I'm not the one to (inaudible). There is a clear, concise, consistent formula that we can all point to so that this is not a guess.

You and I could sit here and say, yes, based on that portfolio, based on standard methodology and formulas applied, risk against capital, here's where the number is. That's I think, a huge weakness and it almost makes our companies impossible to manage from a capital base. And we can't sit here every month and wait for another phone call that says we're upping, once again loss expectations even though we all look at the economy in a very different way than we did six months ago. We look at the exposures in a different way. We're going to get a new level of stress losses that create additional phantom capital needs at some number or rating level that we don't understand. That can't be the way that this industry operates going forward. So, we need to get regulation. I think there's a real part of it that we will hopefully see. And then of course there's a lot of discussion of the regulation of the rating agencies. And even in that regard we think that that has real good potential to at least make this a little bit more of a -- a predictable environment.

If they're really required to release, A, what are you rating, B, what did you look at when you rated it, C, what are your assumptions relative to frequency and severity which I think is a real critical issue here, I think that helps. Because if someone's going to publish kind of very large, nonobjective performance parameters that everyone can see and say, wait a minute, we don't agree with that, then I think it leads us into a better situation of having transparency that ultimately leads to credibility. Or leads people to make their own valuations and judgments beyond what is some phantom number of capital that none of us can really get a good appreciation of. It seems to be going in reverse today. We keep getting put on a watch and review. You say, hang on a second, aren't things getting better? Where are we going with this?

So we're hopeful of regulation, we're obviously going to be highly represented as best we can be in any of the discussions. And we look forward to further discussions on this. But if my crystal ball has enough battery power still looking at probably sometime mid-2010.

Okay. And then, as I was looking at the change in the core outstanding on structured, I think it's down about $1.4 billion. In that instance, with just this simple $1.4 billion here, what does that equate to in terms of the amount of capital that was freed up? I understand each transaction is different, but is there any way in general terms that we could make any sort of assumption on any rate of change?

No, you can't because they'll just change the frequency and severity so that -- if you look at our RMBS -- and now I'm going to talk about the combined Company. Next quarter we're going to have a lot of fun talking about a combined Company. In the RMBS world we're writing off on average about $2 billion of exposure a quarter. So if you think about both companies today, it's in the mid-30's in terms of -- I have it here -- about $32 billion max of exposure that's running off roughly a $2 billion a quarter. Every time you run that off, obviously you then further reduce the possibility of a catastrophic scenario that some people might be forecasting because you're just lowering the base of what could possibly go wrong. As soon as we look at that, though, we then get a new model that includes higher probability of future defaults. And you say, well, hang on a second, haven't we had a whole lot of defaults already? Haven't a lot of those defaults been based on what we think are nonproper borrowers or misrepresented or used a front term if you like. And shouldn't that really affect behavior going forward, plus a turning around economy? Shouldn't this be getting better, not worse? And yet you get no relief on that. So you can say capital should be coming -- or the need of it should be coming down substantially because you know running off the portfolios -- the amount of business we're writing today is obviously significantly less than we've put on in previous quarters. So you are running down the portfolio. Of course, more in the structured finance than in the public finance area. And yet all you do is seeing capital requirement going up. So there's an absolute reverse relationship.

Okay. And then I guess speaking of the capital topic, competition in the marketplace, do you -- do you see any new capital coming into the industry, can you provide an update on that?

Well, competition in the marketplace, yes, we'd like some. So, if you can find any, we'd be more than happy to welcome them into the fraternity. Obviously, you know as well as I know there is a new entrant out there. I can't give you anything more than you know in the public. That they anticipate a start at some point in time. And today, basically, it's ourselves and ourselves. It's Assured and Fsa with a small, small -- and I don't think they've heard anything since April at Berkshire Hathaway. So the market is basically us.

Then have you had any -- any trouble managing concentration risk via municipalities state level or what--?

No, not at all. Remember, Assured, thank goodness, this really helps us believe it or not being kind of a funny way because we didn't have tremendous penetration. You think about the portfolio between Assured and Fsa. Number one, we were less than half of their public finance portfolio. So in terms of penetration, our name is not that well concentrated. Number two and more importantly, as Mr. Mills just shared with me and Mr. McCarthy, a lot of today's volume is being placed in the retail market. So there is no capacity limitation on that. So where activity is today really has no relevance to concentration or capacity limits because of a high retail concentration. The institutional guys and who can blame them based on what has happened in the marketplace, have basically backed off. Now we're seeing small returning of institutional investors based on large deals that we've written in the current quarter. That speaks to some institutional involvement. But by and large it's been retail, and retail does not have that same issue of concentration.

Okay. A final question then would be just in term of the state of the state of California and what you make of it there?

Should I make a joke and say it's the best noninvestment grade credit I've ever seen? California obviously has some severe problems that are going to ultimately have to be addressed relative to sustainable budget reductions. And I think they're well aware of their impact and need of the financial markets. And it seems that they've taken measures to quickly try to close the gap, but that gap has not closed permanently. So you've got to expect future action on their part. But it seems like they've got the right kind of discipline and direction. And obviously we've got tremendous amount of exposure to California. But the nice thing is most of it's in general obligation and tax backed arena. So obviously we can sit there and work through a restructure and get our payments and, there might be a delay, which would cause us some temporary cash outflows. But by and large, we're very confident of the ultimate recovery. And, this gets to the rating issue of our friends in California that it's not less than a year ago I think that they were clamoring that they were AAA.

I won't get into that discussion, I just want to make that note. But, this thing like everything else -- we think there's going to be pressure cross the entire municipal arena. Receipts are going to go down substantially across every municipality. That's going to put pressure. Hopefully it drives a greater appreciation of our product and need as we try to work through these things. And we're probably the best avenue for investors to have represent them to work these things out. So this is what we're here for. This is what we do best. Our remediation and surveillance activities is a critical part of our product. It's not just a guarantee and the payment of principle insurance. It's got a whole lot of other features to it that really add value. And that value's going to be shown rather significantly, I think, over the next 12 to 18 months.

Okay. Thank you very much.

You're welcome.

Thanks, Mike.

Your next question comes from the line of Chris Owens with [Tracelet].

Good morning, guys.

Good morning.

Congratulations on closing the acquisition. I just sort of wanted to run through a pro forma scenario with you. It looks like on a pro forma basis you'll have a $10 billion investment portfolio, roughly $7 billion of unearned premiums.

Right.

So assuming that book and maybe you can help me with this, amortizes over the next 10 years. Again, assuming you write no new business from today and you have a 5% yield on that investment portfolio, it looks like you'll have revenues roughly 1.2, 1.3 in outgoing years.

Right.

So my question is, that would be revenues of about $8 to $9 per share. And once the RMBS stuff settles down in the next year or so, what do you think would be an appropriate combined ratio to look at your business on sort of a run rate, couple years out.

That's a -- a great question, Chris, and I would never answer it. But you can look at the historical combined ratios. Obviously we've got a huge capital base. And it's going to be spread over regions -- a reasonably efficient infrastructure. Bringing the two together. If you look at the total value of, say, on our premium and the number you quote, remember, is prior to purchase accounting, and I will tell you all to strap on your seat belts when Mr. Mills takes you through purchase accounting in the third quarter. Because it's unique to say the least. And which we'll actually write up that unearned premium or the preferred revenue side of the Company significantly.

So if you go back to the history of the industry's performance we should have the largest revenue base going forward with the smallest operating base going forward. And as you point out what's the normal run rate. In the old days we ran at virtually no losses other than a marginal 5% to 7% of estimated earned premiums being put away in the loss reserve back when you were able to do that. The accounting's changed obviously for loss reserving. So that's going to change what that normalized run rate is. And you do have the significant dislocation of the economics of today. We might say, jeez, a lot of this was generated off of what was probably improperly structured deals that might have some reimbursement down the road. With the ultimate losses of today's heightened loss ratios, what's a good run rate going forward, we do expect to see more issue relative to, say, the municipal finance that will cause reserves at some point in time. Whether they're recovered or not, you've still got to put them out when you see that, yes, they default and ultimate payment responsibility.

So the run rate of the industry has got a very reasonable loss ratio. Obviously, somewhere less than 20%. We think we'll have a strong expense benefit because of the combined operations and the significant amount of earnings and invested assets. So we're optimistic, but we don't give out numbers.

Yes. I think probably the only thing that I would point out just today the pretax book deals on the combined portfolios only about 4.2%, 4.25%. So your 5% number that you threw out for the investment income might be a little rich.

Okay. But for the amortizing that book, of unearned premiums, is there a--?

It's actually -- I mean, this is one of the hard parts of purchase accounting because it is done on a very granular basis. I mean, you can take a -- a rule of thumb type of thing. But it's not done in a macro level where you just spread it out over 10 years. It's--.

I'm just trying to look at it from a very simple perspective for a simple mind.

Very simply, 10 years is not a bad guess. But, it's -- it may not work that way when you get into the granularity.

Okay. And I guess my second question would be based on the delinquency rates you guys are seeing, it sounds like the 30 to 59-day bucket improved pretty substantially. When do you expect your loss reserves to start paring back? Is that a 2010 story, is that 2011, based on what you're seeing today and putting a run rate on that going forward?

Well, that's the part we can't predict. Obviously we said in the current month that 30 to 59 bucket has come down in some of the deals, especially in the second lien exposure overall delinquencies have come down and probably because you're charging off a lot. So if the current bucket doesn't go up for the second lie because you're charging stuff off, overall delinquencies are down. So in second lien not only do we see the current bucket's down, we see the total (inaudible) go down. That's a good statement, right? That should hopefully lead to a bottom or a flattening of what the reserve activity has been. And the current quarter reflects that. Where we've added in the second quarter for second liens is in the reinsurance area. Where obviously we're getting information from seeding companies and then reflecting that in our books.

So second lien, I'm -- you got a better argument for the overall picture. First lien, you've got the 30 to 59 coming down. If we sustain that for the next three months that we're on this call, next quarter we've had three more months of that, then I'd say that would be a very good fact that would tend to indicate that maybe we're through the worst of it and that we should have less activity throughout the remainder of the year and hopefully get it done by the end of the year and what's going to have the biggest impact is the general economy. You read like we read what's unemployment doing, what new jobless claims are, what's the general overall level of -- of sales retail activity production, that will also have a substantial impact, as well, beyond just whether delinquencies fall or rise, it's going to be based on those other macro economic factors.

Okay. Thank you very much. Once again, congratulations. Thank you.

Thanks.

Your next question comes from the line of [Shulba Frei] with Putnam.

Hi, I just had a quick question on your tax rate going forward. I know you have the Bermuda Reinsurance Arm and such. I just wondered what kind of tax rate we should assume.

That's a great question. Historically Assured Guaranty has had an effective tax rate I guess target if you will. We always expect around the 12% tax rate. Fsa has a very large US operation which is subject to taxation. The effective tax rate will be higher going forward. It's probably going to be more like 18% to 20% rather than 12% in a -- naturally work hard to manage that. But I -- that would be my bet today for 2010.

Okay. Thank you very much. And congratulations again.

Yes.

Thanks.

And ladies and gentlemen, this concludes our question-and-answer session. I would now like it hand the call over, back to Miss Sabra Purtill for closing remarks.

Thank you. And thank you all for joining us on our call today. We certainly appreciate your interest in Assured Guaranty. And if you have any additional questions or require further information, please do not hesitate to contact me or any other member of our investor relations staff. Thank you again and have a good day.

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