Assured Guaranty Ltd (AGO) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2011 Assured Guaranty Ltd. earnings conference call. My name is Gina and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Mr. Robert Tucker, Managing Director of Investor Relations. Please go ahead.

Good morning and thank you for joining Assured Guaranty for our second-quarter financial results conference call. Today's presentation is made pursuant to Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. It may contain forward-looking statements about our new business and credit outlooks, market conditions, credit spreads, financial ratings, loss reserves, financial results, future reps and warranty settlement agreements or other items that may affect our future results.

These statements are subject to change due to new information or future events. Therefore you should not place undue reliance on them as we do not undertake any obligation to publicly update or revise them except as required by law.

If you're listening to this replay or reading a transcript of the call, please note that our statements made today may have been updated since this call. Please refer to the Investor Information section of our website for our most recent presentations, SEC filings, most current financial filings or for risk factors. Please note that we plan to release our second-quarter 2Q -- second-quarter 10-Q at the end of the call today.

Turning to our presentation, our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd., and Rob Bailenson, our Chief Financial Officer. After their remarks we will open up the call to questions. I will now turn the call over to Dominic.

Thank you, Robert, and thanks to all of you for your interest and in support of Assured Guaranty. Before I begin a discussion of our recent quarter I want to assure you that today Assured Guaranty is the same company with a solid capital base, good business prospects and many strategic alternatives that existed prior to the past few months and before the US downgrade.

Now I'd like to review our quarterly results, the performance of our insured portfolio, our new business activity and future opportunities and the status of our S&P and Moody's ratings reviews. We reported second-quarter operating income of $136 million or $0.73 per share, a strong result. Our reported income would have been higher except that there was a charge of $60 million related to the discount rate required by GAAP to calculate our present value of future losses to be paid.

For new business I was pleased that municipal originations, the PVP, were 32% higher in the second quarter than in the first quarter as issuance volume increased in the municipal market. Our total economic loss development was $71 million for the quarter with the single biggest contributing factor, as mentioned previously, being the decrease in the risk free discount rates used to calculate the present value of future expected losses.

This change is not reflective of any credit impairment in our insured portfolio. In fact, if the accounting rules allowed us to use our own portfolio investment rates of return as the discount factor instead of the risk-free rates; we would have recorded very little economic loss development this quarter. And in reality, it is our investment portfolio and its returns that are the exact resources we use to fund these discounts for future loss payments.

In terms of other loss developments, for the municipal market massive defaults had been predicted but, as expected and previously communicated, there's been no sign of that, not in the market as a whole and certainly not in our insured portfolio.

Of course state and local governments are facing budget challenges, but fiscal stress does not necessarily mean that a large number of defaults will occur. And equally important, a default does not necessarily result in an ultimate economic loss to our insured portfolio.

Interestingly for the market as a whole, the level of municipal defaults occurring in the first half of 2011 is actually much lower than the 2009 to 2010 levels. First-half 2011 results reflect $746 million of defaults versus 2009 and 2010 full-year levels at $8 billion and $3 billion respectively.

Additionally, it's important to recognize that some of those defaulted credits were not investment-grade and some would not have met our strict underwriting standards and therefore would not affect the performance of our insured municipal portfolio. Further, Assured Guaranty typically has covenants and/or contractual rights in our insured transactions that afford us remedies not readily available to uninsured bondholders further impacting the potential for an economic loss.

Regarding the downgrade of the US government's credit rating by Standard & Poor's, over the last several weeks since the US was put on credit watch negative we analyzed the potential impacts on Assured Guaranty of rating agency downgrades of the US government.

We currently believe the impact of the downgrade of the US government to Assured's insured portfolio should not be material as related downgrades should be limited to higher rated states and municipalities and therefore the related increase in capital charges should be small.

In looking at our investment portfolio, we may see a one notch decrease in the average credit quality from AA to AA- based on the direct US government, agency and agency RMBS securities we own which represent about 18.5% of our investments.

From a new business perspective, while we are not trying to make a prediction, if credit spreads widen on municipalities increasing their cost of funding this could create additional opportunities for Assured insuring new issues.

And yesterday S&P did put out a research update stating that because of their policy that the sovereign local credit rating creates a ceiling for the financial strength rating of insurers, they have decided to reverse the outlooks of five US insurance groups from stable to negative and downgraded five others.

S&P said this rating action did not reflect a change in their view of the fundamental credit characteristics of these companies. While Assured Guaranty's outlook was changed from stable to negative our AA+ rating was affirmed and it was nice to be mentioned with the other lead companies on that list.

Regarding loss mitigation strategies for RMBS, we have continued to transfer loan portfolios to servicers we've approved to help reduce delinquencies, defaults and loss severities. The goal of this servicer intervention is to achieve significant reductions in both 90-day plus delinquencies and loan modification redefault rates. Also we are encouraging the use of loan modifications and short sales which should improve loan performance and collateral recoveries.

We are continuing to pursue our contractual rights through rep and warranty recoveries in RMBS. In the second quarter we announced an agreement with Bank of America on 29 first and second lien RMBS transactions for a payment of $1.1 billion and for the first lien deals reimbursement of 80% of the paid losses up to $6.6 billion of collateral losses.

This was a landmark agreement for the Company and we were able to recover previously paid losses as well as limit future losses. And as we've said from the start, we want to reach comprehensive agreements with all rep and warranty providers without the use of litigation if possible.

Since closing the Bank of America agreement we reallocated resources towards the other counterparties who provide us with rep and warranty protection, specifically Credit Suisse, UBS, JP Morgan Chase, Deutsche Bank and Flagstar which are among our largest remaining counterparties. We continue to find significant breaches in a large percentage of loan files which include misrepresented income, appraised value in employment as well as the occupancy status of the borrower.

Using Credit Suisse as an example of a counterparty who has not been living up to its contractual commitments to repurchase defective mortgage loans, we have reviewed files for approximately $1.9 billion of mortgage loans on Credit Suisse deals and found that 93% or $1.8 billion contain breaches of reps and warranties. As of June 30 we have submitted $1.1 billion of loan requests for repurchases and currently have an additional $694 million to submit in the third quarter.

To date Credit Suisse has not repurchased a single loan even though our put back process has resulted in approximately $2 billion in collections from repurchases or other payments from other counterparties. The amounts billed represent a multiple of Assured Guaranty's share of the losses and, although these funds would pass through the securitization waterfall, Assured would significantly benefit from the recoveries.

And assured is not alone in seeking redress against Credit Suisse. Credit Suisse is the subject of numerous RMBS related lawsuits and investigations. Credit Suisse has been fined by the financial industry regulatory authority for underreporting delinquencies on subprime RMBS and is also subject to subpoenas from the SEC and the FHFA. To date we count 18 pending RMBS related lawsuits against Credit Suisse by the Federal Home Loan Bank's, monoline insurers and other RMBS holders.

In one of these suits MBIA alleges Credit Suisse put back loans to originators and then just pocketed the proceeds rather than passing them on to the securitization trust for distribution to RMBS holders. Clearly a no-no if accurate.

As I stated, our goal is to negotiate comprehensive agreements. We are well beyond the days of debating whether mortgage loans and RMBS transactions breach rep and warranties and who is liable. It's time for settlement and Assured Guaranty will pursue all of its rights including litigation. And if forced to litigate we will pursue not only rep warranty claims but also damages and all other remedies that would be available to us.

Sadly the situation with Credit Suisse is not unique and we note similar behavior in not fulfilling contractual obligations among the other rep and warranty providers like UBS, JP Morgan and Deutsche Bank. And I expect to release similar statistics regarding these counterparties in my upcoming presentations.

Turning to the rating agencies, S&P continues to consider changes to their proposed financial guarantee rating criteria in response to market feedback. While it is difficult for us to anticipate the final outcome, we believe that most market participants agree with our public comments regarding S&P's leverage test, capital charges and single risk limit proposals.

In addition, based on that preliminary criteria, Assured Guaranty implemented capital enhancement strategies which we believe would meet the majority of any new requirements.

Also the Moody's annual review is currently in process and we are awaiting information regarding assumptions and stress loss estimates prior to their capital evaluation. However, our Moody's capital adequacy should benefit from the same successful strategies to enhance capital that we deployed to meet the new S&P proposed requirements.

Turning to new business activities, in the second quarter new business originations totaled $51.9 million, slightly below the first quarter's $52.5 million, largely due to a smaller contribution from structured finance transactions. Even with the continued uncertainty caused by the S&P proposed ratings criteria changes, we originated 32% more municipal PVP than in the first quarter as market volumes increased.

Based on transaction count we insured 12.1% or approximately one out of every eight transactions sold in the municipal market in the second quarter, which is up from 10.8% in the first quarter and 10.3% in the fourth quarter of 2010. Our market penetration of new issue public finance par volume also increased to 6% in the second quarter, up from 4.9% in the first quarter and 4.4% in the fourth quarter of 2010.

We continue to see good demand for our product in the municipal area as many small issuers rely on insurance to access the market. In fact, in the second quarter almost 90% of our originations were from issues of $25 million or less. We believe that with rating stability at our current rating levels we should be in a good position with respect to our efforts to increase our market penetration rate not only in US public finance but also in the international and structured credit markets.

While most of our recent new business originations have been in the municipal market we are seeing increasing opportunities in international and structured finance areas. One of the new opportunities within the international area includes the replacement of downgraded guarantors on existing transactions; something we believe could be replicated in many other parts of the markets. In the structured finance area we continue to see more submissions and are cautiously optimistic for the balance of the year.

Overall I am pleased with the progress we made in the second quarter. We increase public finance originations, we reached an important agreement regarding rep and warranty claims with Bank of America, and we improved our capital position by purchasing securities we've insured and executing termination agreements. We are at an important crossroad and we believe we have positioned the Company to move successfully beyond these turbulent times.

Lastly, we had a few internal changes during the quarter. I'd like to congratulate Bob Mills, our former Chief Financial Officer who is now our chief operating officer. Bob has been instrumental in the Company's formation and growth and has been with us since the IPO.

I'd also like to congratulate Rob Bailenson on becoming our CFO. Rob has been our Chief Accounting Officer and has over 20 years of experience in the field.

Finally, I am pleased that Robert Tucker, who has been the head of our fixed-income investor relations and has over 25 years experience in the capital markets, has stepped up to lead both equity and fixed income investor relations.

These appointments show the quality, expertise and depth of our management team. And now for the first time I will introduce Rob Bailenson, our CFO, who will talk about our financial results in greater detail.

Thank you, Dominic, and good morning to everyone on the call. Today I will briefly review the financial highlights and then provide you with more detail on the individual components of operating income, followed by a summary of economic loss development in the insured portfolio for quarter. I refer you to our press release and financial supplement for explanations and reconciliations of our non-GAAP operating income and GAAP reported income.

I am pleased to report strong operating income for the second quarter 2011 of $136.3 million or $0.73 per diluted share which brings our year-to-date total operating income to $385.2 million or $2.06 per diluted share. On a year-to-date basis operating income has increased by 35.3% largely due to the execution of the Bank of America agreement in April and the resulting increase in the benefit for breaches of reps and warranties. The comparable operating income for second quarter 2010 was $172 million or $0.91 per diluted share.

In the second quarter of 2011 we received over $900 million in recoveries under the Bank of America agreement which we invested and, as a result, helped to increase net investment income when compared with the second quarter of 2010. Second-quarter 2011 growth operating expenses before deferrals were also lower compared with the prior year and I expect this cost savings to recur in future quarters.

These positive trends in second-quarter 2011 operating income were offset primarily by a decline in net premiums earned which was consistent with our expectations based on scheduled amortization of net par. Despite the market challenges working against us we have continued to generate new business, we have managed to maintain a strong and steady adjusted book value compared with year-end 2010 as new business written, commutations and loss mitigation efforts offset changes in expected losses.

Operating shareholders equity per share was $27.84, up 7.4% from year-end 2010, which equates to an annualized year-to-date operating ROE of 15.6%. I will now turn to the components of second-quarter operating income.

Net earned premiums and credit derivative revenues totaled $296.7 million, down 17.4% from $359.4 million in second quarter 2010. A decline in net premiums and credit derivative revenues reflected the expected scheduled net par amortization of the structured finance book of business and associated unearned premiums.

Some of the decline in the second quarter was offset by refunding the $21 million in credit derivative premium accelerations of $6.1 million due to agreements we entered into with our counterparties to terminate certain credit default swap contracts. Terminating CDS transactions benefits our rating agency capital position and is part of our capital adequacy enhancement strategy.

Net investment income was $101.5 million in second quarter 2011, which represents an 11.7% increase over second quarter 2010. We have been shifting the portfolio to longer duration bonds from short-term funds which has improved our investment yield. Also, income from bonds purchased for loss mitigation purposes and from amounts reserved under the BofA agreement help drive net investment income higher compared with second quarter 2010.

As I mentioned earlier, we have received over $900 million in cash in the second quarter under the BofA agreement. We will also collect an additional $172 million related to second lien transactions by March of 2012. The yield on the investment portfolio was 3.75% in the second quarter 2011 compared with 3.5% in the second quarter 2010. The average size of the investment portfolio increased to $10.8 billion with a duration of 4.9 years in second quarter 2011 from $10.3 billion and a duration of 4.3 years in the second quarter of 2010.

Operating expenses were $48.5 million in the second quarter 2011 compared with $47.4 million in the second quarter of 2010. Gross operating expenses before deferral of policy acquisition costs were down 8.7% due primarily to a decline in compensation costs. These cost savings were offset by lower deferrals of policy acquisition costs in 2011 compared with 2010. I expect operating expenses to be approximately $48 million to $52 million per quarter for the remainder of the year.

The effective tax rate on operating income was 20% in second quarter 2011, down from 30.4% in second quarter 2010. The effective tax rate fluctuates due to the amount of income in different tax jurisdictions. This quarter's improvement in the effective tax rate reflects higher operating income in our Bermuda operations. I expect the effective tax rate on operating income to be 24% to 28% for 2011, but it will fluctuate from quarter to quarter.

I will now turn to losses. As many of you already know, our insured portfolio may fall into one of three different accounting models for GAAP -- insurance, derivative or consolidated VIEs. However, my commentary encompasses the entire insured portfolio as it would be presented under the FG insurance accounting model regardless of the GAAP accounting convention.

Loss expense in operating income is recognized when expected losses exceed unearned premium reserve on a transaction-by-transaction basis. This is a very simplified explanation and I refer you to our loss accounting policy in the 10-K for further information describing some of the complexities involved in the timing of loss recognition.

Expected losses to be paid is the measure of future cash flows net of salvage and R&W, discounted at the risk-free rate. Economic loss development, or the change in ultimate expected loss to be paid, reflects changes in assumptions based on observed market trends, changes in discount rates, accretion of discount and the economic effects of our various loss mitigation efforts. It is the measurement management uses to calculate the loss experience of the insured portfolio, but keep in mind that it also includes changes that are due to discount rate fluctuations.

Total economic loss development was $70.9 million or $49.6 million after-tax during second quarter 2011, most of which was associated with the insured US RMBS transactions. As Dominic mentioned earlier, the largest individual factor contributing to net economic loss development was a decline in the risk-free rate used to discount losses which accounted for approximately $60 million of the total economic loss development.

The component of loss expense that is attributable to the change in discount rate is not indicative of additional credit loss. Interest rate movements will always cause fluctuations in our loss expense as the accounting rules require us to reset the discount rates every quarter. This change was most pronounced with long dated expected loss payments principally in the RMBS sector where discount rates decreased by approximately 30 basis points to an average of 4.1% for these transactions.

The difference between our economic loss development of $70.9 million and $144 million in loss expense is essentially expected losses that were absorbed in the unearned premium reserve in prior periods and are now recognized in the income statement.

As discussed in our first-quarter earnings call, we entered into the BofA agreement in April of 2011 which provided us with certainty regarding R&W recoveries for 29 BofA transactions. The BofA agreement is accounted for as salvage and subrogation.

As we update estimates of loss for the first lien of BofA transactions each quarter, we include an 80% benefit of R&W up to $6.6 billion of collateral losses. As of June 30, 2011, cumulative collateral losses on the 21 first lien transactions were approximately $1.6 billion and as of June 30, 2011 we estimated that lifetime collateral losses on these transactions would reach a total of $4.8 billion.

I'll now turn the call over to her operator, Gina, to give you the instructions for the Q&A period.

(Operator Instructions). Mike Grasher, Piper Jaffray.

Thank you and good morning, everyone. Dominic, the first question I have is how much capital would you estimate that you raised internally with the debt repurchase in the quarter and then the contract cancels?

Since we initiated the process, Mike, including everything we've done so that the rep and warranty settlements, terminations, and purchase of insured securities, we estimate capital in excess -- and runoff -- capital in excess of $2 billion has been freed up and/or created through those specific transactions. So that takes us back to when S&P announced the criteria potential changes back in January.

So the number is in excess of $2 billion at this point in time?

Yes, for our models. Remember, these are our models, not theirs. We try to be as accurate as we can. But that doesn't mean it's exactly on the nose, but we think around that kind of number.

Okay. Next question just with regard to the rating issues that are occurring with S&P. What's the change in the multiplier when a downgrade occurs on one of your exposures in your portfolio, say it goes from AA to A+? And then what's the degree of change if you have an issue that's sort of downgraded from say A- to A, or even A to BBB+?

Mike, I guess you're preferring to the cap charges in their models based on the rating continuity of the underlying security.

Exactly.

Right. Well, obviously this would affect predominantly municipal. And although the municipal criteria is changing so we really can't be exactly accurate from an S&P point of view, from a Moody's point of view, because severities are very low and even probability of default going from a AAA to AA+ is rather insignificant.

As I said in our earlier comments, we don't expect any significant changes in capital requirements. In other words, that number should be incredibly small, probably within my guess $100 million, but that's a guess, and that's probably at the far end of the spectrum. We don't expect this to be a significant issue relative to the individual downgrades of outstanding municipal transactions.

Okay. And then sort of the rate of change. I mean if you go down the ladder to a little riskier holding (multiple speakers)?

Yes, the big change, Mike, would be if you fall out of investment grade. There's a huge cliff in these deals. So going from AAA to AA or even AA to an A+ is not significant, it's only after you fall out of investment grade that you really see significant changes in capital requirements.

Okay, thank you. And then final question, just your commentary around Credit Suisse. Just to confirm, this is not currently in your receivable for the R&W put backs, is that correct?

That's a good question. If there is a number out there it's under -- it's a low number if I remember correctly. Hang on a second; we're pulling the number for you.

So you're saying you've submitted $1.1 billion.

Yes, we might have like $130 million receivable up, it's not significant.

Okay, okay. Thanks very much.

You're welcome. Yes, Mike, Credit Suisse we have $56 million up, to give you an exact answer.

John Helmers, Swiftwater Capital.

Hey, guys, Dominic, thanks for taking my call. My question here is why would you not, in this current uncertain environment, consider stock purchases? Because we obviously -- the goal is to have the best credit rating possible.

But I would imagine even $200 million spent buying stock here given the massive chasm between [ABV] and the stock price and that same $200 million, you would expect, would not make a critical difference in your end rating. And waiting until you do get confirmation would give you a much lower probably opportunity to buy your stock at a low price.

So far we disagree with nothing that you've said. Remember we are in blackout period. We also have to consent ourselves with other information that we are aware of.

No, I don't mean yourselves; I guess I mean the Company itself.

Oh, the Company. Even the Company can't -- is pretty much subject to the same rules as we are as persons, right. So we've got to look at blackout periods, we also have to look at other information known. But we are well aware of the usually accretive nature of a stock buyback.

As you know or as we've communicated previously, we would have liked to have gotten more clarity around rating agency capital required levels. We appreciate that the amount of our authorization today is rather insignificant relative to that total. And we will consider and take appropriate measures once we clear blackouts and we're confident that we know of no other material information that's not disclosed to the public.

So it is possible -- that is in consideration?

On a playbook that we look at on a daily basis, that's one of the plays in the playbook.

Because obviously it seems like the more uncertainty there is from a rating agency perspective the more -- the bigger the cost is for you guys. And to a degree; I mean I happen to be in Warren Buffett's camp that the US should be a AAAA if anything. Their credibility is only going down. So investing obviously and having their stamp of approval has arguably less value as we go forward.

Yes, (inaudible), but we live and die by that sward. So we appreciate the comment and we obviously appreciate the significance of the accretiveness of a buyback. We understand where our authorization is for buyback today, should not have a material impact. And as I said, we've got issues to deal with internally regarding blackout and other considerations and that's the strategic alternative that we will continue to evaluate.

Well, the last thing on that, Dominic, is, in your opinion, is adjusted book value a -- is the best measure to think of when one as a longer-term investor [like for a quarter] is thinking about the underlying intrinsic value of the business?

Well, the only issue with adjusted book is it really doesn't forecast future expenses and obviously it has a very low loss content based on a more normalized portfolio. So that's the only real issue I have. We like to look at operating book value as a reasonably strong measure and I think that number is in the $27 range at this point in time. So still usually -- our stock price is usually undervalued when considering that measurement.

Thank you very much.

You're welcome.

Brian Meredith, UBS.

Hey, good morning, Dominic. I'm wondering if you can talk about where you stand on your leverage ratios, if you kind of take a look at what the S&P proposed model had. How do you stand from a capital standpoint when applying current -- your current portfolio to that model?

Well, you know -- good question. So they came out with a leverage test which is just a hard coated par against capital. Obviously they look at stat capital. The big question there is whether they're going to allow either all or some consideration for the UPR as part of the denominator. We believe with no changes that we would meet the leverage set by year-end.

Since we've accelerated more terminations than was in that original forecast I think we're probably closer to that. It might be a third-quarter achievement number because we continue to look at opportunities in terms of the negotiating terminations. We just accomplished another one yesterday as we speak for roughly about $2.2 billion of par. So we continue to do that pretty well and that's the whole issue around leverage, it's simply the par number.

So as I said, we thought that we would get comfort by year-end, I think we might be ahead of that schedule, and that was considering no benefit from the UPR which we believe was one of the most popular comments that S&P did receive. So if we think there is going to be a modification that's probably one of the easier ones that would probably have some change to it.

But, be that as it may, to your original question, we think we're pretty close. We had an original forecast at 12/31; we're probably ahead of that schedule today.

Great. And then, Dominic, my second question is -- looking at your RMBS kind of portfolio right now what's the sensitivity currently particularly for additional losses if we go into another recession?

Well, you know, we've been trying to factor in kind of the double dip in housing and what would another 20% decline in housing values do. A couple things to consider there is, one, ultimately our net loss exposure or ultimate result for RMBS is going to be predicated on the rep and warranty success or activity that we have.

Obviously we feel very comfortable with our position. I think the Bank of America agreement was a real statement in that regard. As we look at litigation out in the marketplace we're very pleased with most of the direction being very positive to the monolines and other people pursuing rights and remedies, so that's all going in our favor. So that's ultimately going to dictate how much money we win or lose on residential mortgage backs.

Looking at it from the standpoint of just pure loss, one, those exposures continue to pay down roughly $1 billion a quarter. I think today we only have about $16 billion that's below investment grade in that area, so it's a lot smaller number than when we started this thing say back in 2008.

Two, these are very seasoned. As you look at the portfolio today the majority of the vintages are '05, '06, '07. So even the '07 year is now four years old. And if people have made the decision to defend their mortgage and defend their house for that four-year period, we're confident that their default rate, other than if there's a huge spike in unemployment, should proceed on a lot more less dramatic result than what we've seen in the past.

So the exposures are less, the borrowers are stronger; most of the misrepresented borrowers have either defaulted or are in the seriously delinquent category, which we already default anyway within our reserve model. So we don't anticipate that big of a difference to be achieved or to be absorbed if there is a setback, if there is another dip.

And the same could be set of corporates in our TruPS. All those exposures are down reasonably low or better than they were. Most of the bad guys or the guys that were weak in those portfolios have already defaulted. The level of say bank failures is a lot less, the level of bank failures and TruPS are a lot less.

So we're seeing a lot of positive trends. And although, yes, you can expect some further fallout from the current economic situation that we're in, we're comfortable with where we're at vis-a-vis total exposures and the individual risks and protections that are still remaining in those exposures that we feel that we'd be in pretty good shape in that regard.

Okay, and then one last one. Just question your thoughts on the impact of the debt ceiling on municipal finances and what do you think about that going forward?

Well, you know, we looked at all the credits in our portfolio that rely on federal intervention and there wasn't that many. Obviously the healthcare is probably the biggest one from a Medicare and Medicaid perspective. They're all in tough economic times. I think that in most cases various states and municipalities have balanced budget requirements, which kind of keeps the kind of focus on the ball.

We do expect a shortfall or a drop in state aided fund and obviously federal to the state. But we think the portfolio is in reasonably good enough shape that it will be able to withstand those numbers. As I said, if you look at the economy we've been in, really we sit here and talk about two municipal credits that are troubled significantly being Jefferson County and Harrisburg.

And if you looked at the press, both have deals on the table today that we as a bond insurer are supportive of. We think obviously it significantly improves the position and we hope that they will be passed in the upcoming days or weeks and let those credits move on to a lot more stable or healthier positions.

So we haven't seen a whole lot. We think the portfolio is very well protected. Where there is troubled exposures the exposures are down and what's left is still pretty stable and solid and I think can withstand a fairly reasonable amount of further stress. And we continue to look for other solutions that will further mitigate either those exposures or potential losses within those portfolios.

Thank you.

You're welcome.

Sean Dargon, Wells Fargo Securities.

Thank you and good morning. I was wondering if you had any insight as to the timing of when S&P would release the bond insurance criteria. Originally they had said early in the third quarter.

Yes, I would tell you that you need to ask them that question though. Obviously we anticipated early third quarter with our individual determination be resolved by the end of the third quarter. We hope that they still meet that second timetable; we don't think it's too complicated, once you lock into the final criteria, to run our numbers.

Obviously we just had a review, as you well know, by them that confirmed our AA+ stable as required of the government downgrade, but are AA+ stable valid a month and a half ago using the old criteria.

Well remember, even in the new criteria about 60% of the requirements are what I'll call qualitative, not quantitative, so it's like risk management, governance, controls, enterprise, risk management, portfolio, those types of things. Well, they're not going to change from new to old criteria. If you liked their risk management then you're going to love it now. If you like their underwriting guidelines and discipline that shouldn't change.

So because of that 40% it's going to be quantitative and these are -- typically the major impacts of the quantitative one. We hope to see a very quick turnaround of that and we're hopeful that it happens before the end of the third quarter because we like to look at the fourth quarter kind of on a very stable solid ratings based that will allow us to really be more accepted and more beneficial to issuers in the marketplace.

Sure, thanks. And as it regards the discount rate, can you give any sensitivity to what say a move in the 10-year -- I don't know if that's the benchmark. But what a move in interest rates translates into in terms of the impact to your losses? Because the yield on the 10-year is down roughly 70 basis points or so since the end of June.

Yes, I'll let our new CFO answer that question.

Yes, we'd see, Sean, that about a 30 basis point movement in the 15- to 20-year range on the yield curve -- actually 15-, 20- to 25-. That 30 basis point movement would be about a $60 million adjustment to our reserves. So, is it linear? I wouldn't say it's actually linear, but I would say 70 basis points could be anywhere from $70 million to $100 million.

Okay, thank you.

You're welcome.

Nat Otis, KBW.

Hey, good morning. All my questions have been answered. Thank you.

Larry Vitale, Moore Capital.

Hi, thanks, Dominic. Good morning. I have just a few sort of housekeeping questions. There was a question earlier about how much in the way of tear-ups and that that you have done, and you said $2 billion. My recollection is it was roughly that at the end of Q1. Do you have handy what you guys did during Q2?

Yes, we do. No, but the $2 billion number, Larry, just to be clear, was something we tore up yesterday. So I'm just saying we continue to affect that capital mining technique and looking for opportunistic chances to terminate currently insured balances. We have done -- prior to that, the most recent tear-up we have done, $8.8 billion year to date, to kind of give you the numbers. So, it was $2 billion in the first, it was $6 in the second, and we've got another $2 billion so far in this quarter if not more.

And that is notional amount or the amount of capital relief that you would experience?

That's notional part. The capital relief, Larry, that we talk about that approximated $2 billion is made up of all of the strategies, so it includes the benefit from the settlement with Bank of America and other rep and warranty activity. It includes tear-ups of CMBS transactions as well as these pooled corporates. It includes repurchasing of our insured securities. It includes the runoff in the portfolio. So that's the overall total. So we quote par on terminations, we quote capital when we refer to all the capital enhancement strategies.

Okay, okay, that's helpful. And then just on the muni side, do you have handy the stats on muni downgrades and upgrades I suppose in Q2 and year to date?

Downgrades have been outpacing upgrades by about two to one which is obviously very different than what was previously say in the '09-'10 when it was six to one going the other way. Obviously we rate everything internally. So although we look at the external ratings it's our internal ratings that drive our reserves and how we look at the portfolio, our below investment grade, etc., is based on our rating.

So we monitor them because it will affect the cap charge that we get from the rating agencies, but it's a monitoring. So, yes, we noticed that the downgrades outpace upgrades and we expect that to continue through the balance of this year at least.

And that two to one is on your ratings?

No, it's on the rating agency ratings. On our ratings it's probably similar. Remember we had them lower on average anyway because we didn't have a recalibration.

Right, understood.

(multiple speakers) Assured Guaranty.

Okay. And then finally, you got $900 million of cash from Bank of America and I'm -- you don't -- at least if you do I didn't -- I missed it. I'm trying to figure out where that cash went by comparing the Q1 balance sheet to the Q2 balance sheet. It seems that most of it ended up in the investment portfolio, but I can't reconcile where all of it went. So if you could help me out with that that would be great.

Yes, I'd say 90% of it went to the investment portfolio. We had positive cash flow over the six months. Obviously that would be a lot of it. Obviously we do pay dividends and expenses but we should have enough coming out of the investment portfolio to meet most of that requirement. So, yes, we'll provide you a reconciliation or we'll make sure that that information is in the supplement.

Okay, and then finally, just on the whole discussion on buyback. Your equity market cap closed yesterday at $1.9 billion and you said the present value of the BofA settlement is $1.6 billion. And I'd just sort of leave it at that.

Yes, thanks for that fine statement, Larry, I appreciate it.

Okay.

I'll take out my razor and I'll be with you in a moment.

Thanks, Dominic.

You're welcome.

[Michael Tang], [Goss Capital].

Hi, actually it's [Andrew Goss]. I was just wondering if you could just take us through, if you'd be willing, kind of how you think about if you just went into runoff right now and bought back stock, like what kind of value you could potentially realize.

Gee, that's the old question like if you hanged yourself how long would it take you to die. Obviously we consider a lot of scenarios, that's not one that we think is the most beneficial for the Company. I think we can run numbers, as you could as well. You've got an adjusted book of 50, you've got an operating book of 27, you're currently selling in the 10 range, how much stock could you buy back. It's a mathematical question at that point in time as to what the value of the Company is.

Since we're very comfortable with our financials, with our reserves, with how we state everything on the records that those book values and adjusted book values -- as I said, the adjusted book has got some adjustments in it that you'd have to make. But we think they're all reasonable approximations of the ultimate value in the Company. So, do your math. If you buy it back at 10 what does it do to book, what does it do to adjusted book. I think it's a very positive number.

Now could you free up all that capital to do it? Would the regulators allow you to move that strongly in creating dividends to buy back the stock? These are some of the fundamental administrative type questions that you'd have to answer. But we have some strategies that would allow us to deploy a certain amount of significance, a certain amount of capital to do that. And we'll continue to look at those numbers and continue to go through that thought process as we see the events unfold.

But, I mean is it fair to say just based on what you just said and the adjusted book value and so on that -- I mean, you think in a scenario like that the ultimate value of the Company is a multiple of where it is right now, I mean like 30, 40 --?

Well, it has to be higher, right, if you're going to buy it back at 10 and you think (multiple speakers).

Well, no, but what I mean is like if you're saying the adjusted book value -- if the adjusted book value or some approximation is some kind of indicator of the value of the Company, then the -- and you'd be buying it back at kind of a 20th of that or whatever -- (multiple speakers) I mean a fifth of that, whatever.

I mean doesn't it stand to reason that -- I mean you could triple whatever the stock price was from doing that? I mean, I just wonder why it makes sense to keep running it if -- if this adjusted book value really does represent kind of the intrinsic value of the Company and you could just kind of play that out and triple the value.

Yes, I don't want to cut you off, but obviously we've had a lot of discussion around buybacks. We appreciate the significance of that opportunity. We obviously were very concerned of where ratings capital was going to go.

Obviously we think we've done a lot of things to really modify the impact of that and therefore we put ourselves in a better position to continue all parts of the capital management strategy, of a shareholder value creation strategy. And as I said, we're in blackout, we've got some other strategic things we need to clear prior to us being able to be active in the stock and we're doing all those things as we speak today.

Okay.

Thank you.

(Operator Instructions). Scott Frost, Bank of America-Merrill Lynch.

Hi, thank you. You touched a little bit on the portfolio surveillance process I guess for the effects of a downgrade and -- with respect to the debt ceiling. It's understandable that you wouldn't expect a downgrade to really have a whole -- from AAA to AA plus -- have a serious impact.

But one of the things I'm wondering about is the longer-term effects on Muniz will depend on federal support -- consideration of potential budget cuts that are contemplated as well as future cuts that might be necessary if regaining the AAA rating is a goal of. Can you sort of touch a little bit more on the mechanics of your portfolio surveillance process with respect to potential budget cuts?

I mean the first round is I guess defense, non-essential spending then another round is supposed to be enacted in November. Have you thought about potential cuts and the effect on muni bonds that you [rep]? Does that make sense?

Sure. Well, first and foremost, any cuts we believe will be more impactful on new projects and new financings going forward than the past, right. In most cases we look at our exposures which already have either a dedicated revenue stream, tax obligations or the general obligation of the specific issuer as the support structure for those debt service payments and that's kind of been locked over the past.

And as I said, we didn't take a look at the portfolio to see where there was any reliance on government type funding which principally has been a specific project area like transportation or in the healthcare field for Medicare/Medicaid. So, we know those credits, we know what our revenue coverage is and we're very comfortable with those exposures and the impact at the downgrade.

And as I said, we think most of that debt ceiling and the very much further pressures that will put on the ability of the government to finance other things will really be more new project specific. And we monitor our underwriting very, very closely on new municipal activity. To give you a statistic that we have -- I'll pull up the right one here in a second.

So we looked at our submission activity that we have in the quarter and a good example would be in the quarter we decline to even consider underwriting 30% of all submissions, we reviewed and rejected another 15% for creditor legal structure issues. So you're looking at about a 45% declination just to kind of show you that we pay attention to essential services, we pay attention to the support of the foundation of the revenue backing each obligation that we consider for insurance.

So that's kind of how we're taking this on a prospective basis. And as I said, we did the retrospective review of the portfolio for specifically that reliance on US support and are very comfortable with the exposures that we have.

Is there any sort of contemplation of -- is the federal government as a significant part of the local economy for example if a military base is closed, something like that? Is that also part of the surveillance process?

Yes, military housing would be one of the big issues, but we have very, very small exposures in that area. But you're exactly right, military housing is a big one in that regard.

Okay, all right, thanks.

You're welcome.

Randy Raisman, Chatham.

Can you guys address just the increase in the loss and loss adjustment expense reserves in AGMC from Q1 to Q2 from like $37 million to $491 million just in the supplement?

Well, remember in the (inaudible). It's going to be more predicated on the receipt of the rep and warranties because, depending on what you're looking at, net reserves would be the reserve minus the asset. As the asset gets paid down then the reserve goes up, but it doesn't go up, it's just that the offset against it is smaller.

So you should -- just -- so you should net what you expect to receive from rep and warranty against it, is that the way to think about it?

It depends on the presentation. Obviously we felt that there was economic loss development of about $140 million in the quarter. If you take out the PGAAP it's down to $70 million. And we said the $70 million -- the majority of that, 60 of it was the change in the discount rates.

Yes, I mean, the economic loss development, just to be clear, is $70 million. That's -- $60 million of it was related to discount rates. The additional $74 million was already embedded within the unearned premium reserve and was set to go regardless of any change in credit. So there's $144 million coming through the income statement and there's -- of that $144 million, $70 million was related to economic development and $60 million of that was interest rate.

It depends on what presentation you're looking at. In some cases for stat it's net, for GAAP it's not. So I don't know what you're referring to specifically. But the collection of the rep and warranty asset on an individual company basis on a stat basis will increase reserves.

Yes, and if you're looking at the claims page in the supplement, you're seeing the increase in reserves. What that is is the collection of the cash from the BofA transaction. By collecting your cash you effectively increase your reserve and you get a benefit from claims paying resources.

Okay, thank you.

Yes, it's complicated. We apologize for that, but the accounting doesn't leave for a simple path or reconciliation.

Got it.

Due to the interest in time that concludes the Q&A session. I would now like to turn the call over to Mr. Robert Tucker for closing.

Thank you, operator, and thanks to all of you for joining us today for our conference call. If you have additional questions please feel free to call either Ross Aron or myself. Thanks again.

Ladies and gentlemen, thank you for your anticipation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.