Assured Guaranty Ltd (AGO) 2012 Q3 法說會逐字稿

Good morning and welcome to the Assured Guaranty's third quarter 2012 earnings conference call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Robert Tucker. Please go ahead.

Thank you, operator. Good morning and thank you for joining Assured Guaranty for our third quarter 2012 financial results conference call.

Today's presentation is made pursuant to the Safe Harbor provision 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 rep 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 are listening to a replay of this call, or if you are reading the 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 recent presentations, SEC filings, most current financial filings or for the risk factors.

In turning to the presentation, our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Limited, and Rob Bailenson, our Chief Financial Officer.

After the remarks we will open the call to your questions. As the webcast is not enabled for Q&A, please dial in to the call if you would like to ask a question.

I will now turn the call over to Dominic.

Thank you, Robert, and thank you all for joining Assured Guaranty for our third quarter 2012 earnings call.

During the third quarter we continued to deal with the challenging business environment by pursuing our core strategies that have allowed us to achieve positive operating earnings every quarter through the financial crisis.

These include disciplined new business origination, within the constraints of our rigorous underwriting and pricing standards; the recapture of business previously ceded to reinsurers; the purchase of our own insured bonds, in order to mitigate loss, improve rating agency capital and acquire assets with attractive yields; the pursuits of recoveries for breaches of rep and warranties and residential mortgage securitizations; and agreeing to the termination of selected transactions to reduce rating agency capital charges, while retaining our premium income.

Our operating income in the third quarter was $166 million, up dramatically from the $38 million in the third quarter of 2011, due primarily to higher net earned premiums, lower loss expense and a lower effective tax rate on operating income.

As most of you are aware, we are now in the eight month of Moody's review of our financial strength rating. Moody's has stated that it anticipates resolving its review during the first half of this month.

After publishing a score card in March, showing us solidly in the AA category, we cannot comprehend how Moody's could consider a downgrade when we have only grown stronger since March, through $38 billion of exposure run-off, $85 million of present value new business production, and a greater certainty about the performance of our insured portfolio as it matures and amortizes.

We believe that Moody's arguments, suggesting a possible downgrade, are mainly subjective and unsupported by the facts. We are still in discussions with Moody's and believe that there would be no justification for a downgrade. I know that many policyholders and shareholders have expressed this same view to Moody's.

Turning to third quarter production, Moody's was overdue to finish its review every day of the third quarter and the market believed that an announcement was imminent. This had a negative impact on our business production, because many issuers and their advisors did not want to risk a rating change between the pricing and the closing of a transaction.

However, even with the Moody's uncertainty and historically low interest rates, we continue to offer meaningful value to the market. This was evident in our strong third quarter performance in the secondary market, where we have increasingly been asked to insure substantial portions of bonds that were previously issued without insurance.

Of our $35 million of total US public finance PVP, more than $7 million was gained through the secondary market, which is more secondary business than we did in the entire first half of this year.

The quarter's $500 million of secondary market par written was more than in any quarter since 2008. Our third quarter US public finance gross par written totaled $3 billion. In our target market of underlying single-A transactions, we had a very good year so far, guaranteeing 31% of the transactions sold and 12% of the par.

Since September we have made several strategic staff additions to support new business growth in our US municipal group. We've hired three seasoned managing directors to lead our national new business efforts, drive our outreach programs to sales tradings and syndicate desks, and manage our Western region public finance group in San Francisco.

We also recruited another director, a talented bond insurance underwriter, to further strengthen our efforts in the West.

These new contributors bring many years of experience and strong industry relationships to Assured Guaranty, and we look forward to them helping us build on our leadership position.

In US structured finance, during the third quarter we guaranteed the senior notes of a $225 million securitization of small equipment loans and leases by LEAF Commercial Capital. This transaction obtained a AAA rating based in part on the risk oversight we provide as the control party and financial guarantor. The transaction proved the value of our insurance, and should help us win additional asset-backed business in the future.

In the international market, transaction lead times are very long, and production from quarter to quarter, and even year to year, is lumpy.

We continue to see increasing inquiries as banks in Europe are retreating further from infrastructure lending activity, which improves our position by making capital market solutions more important.

We also continue to seek opportunities in the monoline replacement area and have targeted a number of deals for 2013.

Turning to loss mitigation and capital enhancement, during the third quarter we purchased $88 million of Assured Guaranty wrapped bonds in five transactions, whose average yield of 7.6% enhances our investment returns.

Also in the quarter, we agreed to terminate seven transactions totaling $682 million of net par outstanding, while still collecting 103% of the expected premium and augmenting our rating agency capital.

In the RMBS area, early stage delinquencies remain well below their January levels in all categories.

Closing arguments on our Flagstar trial are scheduled for Monday, and as the first monoline case to go to trial over claims tied to the bundling of mortgages that were sold to investors, it's being watched closely by a broad audience of interested parties.

This case has already produced an important ruling by US District Court Judge Rakoff that a breach of reps and warranties does not have to cause a mortgage to default for us to obtain relief. Other courts have reached similar conclusions.

Additionally, a trial dated May 2013 has been set for our UBS litigation. This case will be heard in federal court, and this is an aggressive and favorable schedule compared to the normal length of time between the filing of litigation and the setting of a trial date.

We also have a case in progress against Credit Suisse in New York State Supreme Court, where on a ruling on a motion to dismiss, the judge ruled that we cannot seek certain types of damages, principally rescissionary. We will appeal that decision.

Our cause of action for breach of rep and warranties and breach of repurchase obligations and related damages, however, remain, which are critical components of the case.

In public finance, there have been some interesting developments related to pension funding in California.

In September, the State passed pension reform legislation that should help bring pension cost for future public employees more under control. We are pleased to see California take steps toward addressing a clearly unsustainable public pension system.

On a local level, San Bernardino and Compton, communities where we do not have general fund exposure, have moved to treat pension obligations similar to other unsecured creditors as part of their strategy to address their fiscal challenges.

We have been active in educating the general public about the reality of municipal bankruptcies, and the value our product delivers in such instances.

Assured Guaranty was featured on two national news programs during the quarter, and we continue to look for opportunities to deliver our message, which is, when you buy a bond, there is no better way to make certain you receive your timely payments than to make sure it is insured by Assured Guaranty.

We will also be increasing this emphasis in our advertising on how our bond insurance has protected investors in these very real situations. We believe these efforts will have a positive impact on business production going forward.

In looking at future opportunities, we recently commissioned a SourceMedia survey of municipal market participants. The responses confirmed that there remains demand for bond insurance, and that that demand will increase once we have stable ratings, and as interest rates rise and credit spreads widen to levels more consistently with historic levels.

As the Fed appears more determined to keep rates very low until they see much more economic recovery, we are soundly positioned to capitalize on these opportunities based on our financial strength, market position and dedicated resources.

We are confident about our ability to serve our markets and build our business, based on our proven value proposition. We have also confidence that informed investors understand our true strength and the value our guarantee provides. And, as always, we are committed to protecting our policyholders and building long-term shareholder value.

Now I'll turn the call over to Rob.

Thanks, Dominic, and good morning to everyone on the call.

As Dominic mentioned, we had a significant increase in operating income this quarter. Operating income for the third quarter 2012 was $166 million, or $0.85 per share, compared with $38 million, or $0.21 per share, in the third quarter of 2011.

The results reflect higher premium earnings, lower loss expense and a lower effective tax rate.

In the third quarter 2012, refundings and terminations totaled $73 million, and were the primary drivers of the increase in net earned premiums. This compares to total refundings of $27 million in the third quarter of 2011.

The record low interest rate environment encouraged issuers to refinance or refund their debt obligations. In addition, our proactive efforts to delever the insured portfolio continued, as we have terminated certain policies resulting in the acceleration of net earned premiums.

Total economic loss development was $64 million, half of which related to an increase in expected losses in Spanish sub-sovereign exposures. In third quarter 2012, we downgraded several of these exposures.

In the US RMBS sector, development was modest in comparison to prior periods. In addition, the Company established additional loss adjustment expense reserves as we continued our loss mitigation efforts.

As you know, economic loss development is different than loss expense, due to the amortization of unearned premium reserve on transactions with expected losses. In the third quarter 2012, loss expense was $100 million, which was significantly lower than third quarter 2011 loss expense of $254 million.

Primary reason for the decrease is the effect of changing risk-free rates used to discount losses. In third quarter 2012, risk-free rates used to discount losses did not change significantly and therefore had minimal impact on loss expense. However, in the third quarter 2011, the significant decline in discount rates had a negative effect on loss expense of approximately $120 million.

The effective tax rate on operating income was 23% for the third quarter 2012, and 32% for the third quarter 2011. The effective tax rate varies from quarter to quarter, due to the amount of income in different tax jurisdictions.

Non-taxable jurisdictions generated operating income in third quarter 2012 compared with operating losses in third quarter 2011. The year-to-date operating effective tax rate was 24%, which is in line with expectations for annualized effective tax rate.

The other major drivers of operating income are generally consistent with our expectations.

As always, I refer you to our press release and financial supplement for explanations and reconciliations of the non-GAAP financial measures that I reference in my commentary.

I'll now turn the call over to our operator to give you the instructions for the Q&A period. Thank you.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Mark Palmer, BTIG.

On October 31, Moody's, in their announcement that they would be coming out with a decision on the outcome of the review, noted that they had -- that it was partly because of Hurricane Sandy, and partly because they wanted to give the Company an opportunity to provide additional info.

Given that, as Dominic noted, we're eight months into this review, what additional information are they looking for? Was that the Company's third quarter results, or is there something else that they were referring to?

It was more than third quarter results, Mark. So how this works is, first and foremost, they typically give us a capital model and then, as we go through the capital model and break down the exposure by segment in our portfolio, we then try to look at assumptions and results.

We recently, and I'll say within the last two weeks, got an overall capital assessment. And then, as we started to break it down by component risk in the portfolio, obviously that generates a lot of questions.

At the same time, there is a lot of verification of data that's required. Obviously, when you look at a portfolio of our size, and the number of transactions that it holds, and not every deal is exactly as the deal would be if you just, say, looked up a CUSIP because theoretically we could have an indemnity agreement that provides greater protection, higher subordination, that had to be included.

So it's really a matter of analysis of portfolio capital charge, verification of data, understanding of assumptions, re-running those assumptions against our own models to see if we can reconcile results.

So I would say the information was more in the term of feedback, verification, assumption analysis and re-checking of results.

Okay, thank you. Also, you mentioned that you've got the upcoming trial scheduled with UBS, and also the ongoing Credit Suisse action. Was there any change at all in status of communications with those counterparties during the quarter?

Not that I'm able to discuss. Obviously we would expect, once any decision is reached, especially to the positive, we would expect dialog to pick up substantially. As the trial goes on, obviously there's been some pretty good rulings that we feel very strongly about.

But I think a verdict will be the biggest enzyme or accelerator in terms of getting further discussions. But we have active dialog, as you can imagine, continuing across a lot of fronts.

Very good, thank you.

(Operator Instructions) Bill Clark, KBW.

Dominic, in your opening comments, you mentioned some deals where issuers were concerned about closing it before, or in front of, a rating agency decision. Now, what happened to those transactions? Did they go ahead and issue without insurance? Are they still in the pipeline, or something else?

I'd say the majority of them went ahead and issued without insurance.

Obviously, as we've talked about in a lot of calls, today the insurance market is a buyer's market, not a seller's market. And that's why it's incumbent upon us to continue to go out and talk about value, contact each individual component of the market, being bankers and issuers.

And the nice thing about our business is, even if you miss out on your opportunity to do the business in the primary market, obviously that opportunity comes back to you in some cases, and as we noted in the quarter, a significant volume in the secondary market.

And remember the, what I'll call, return dynamics are very different in the secondary market than the primary market. In the primary market, you're trying to sell insurance, and convince the issuer and the banker that insurance is the way to go. In the secondary market, somebody's coming out and trying to buy your insurance.

So obviously the opportunity -- and we try to go back and look and say, okay, if we're able to create this kind of a pricing mechanism for secondary, does it not indicate that the issuer potentially left some money on the table in terms of really valued savings? And we try to go back once again, and communicate that to the banking public.

But long answer to a short question, yes, I'd say the majority go out and then we see those opportunities, hopefully, in the secondary market.

Okay. Thank you very much.

Larry Vitale, Moore Capital.

Did you receive any rep and warranty payments, recovery payments, in the quarter? It looked like there were $95 million, but maybe I didn't read the supplement right.

That's correct, Larry. It was $95 million.

Okay. Can you tell us anything about those?

Primarily they're related to the loss sharing arrangements that we have with both Bank of America and Deutsche Bank.

There were payments outside those two agreements. I think that number was about $10 million.

It's $10 million.

The majority of the payments, Larry, come out of the shared loss agreements that we have, and there was another roughly $10 million that came out of non-agreed-upon settlements, where we still see activity in terms of payments.

Okay. And then I just wanted to ask you about your exposure to both Spain and Greece. It looked like your Greek exposure fell off. I'm not sure what happened there.

And then, if you could give us any color on your Spanish exposure, that would be great. Thanks.

Sure. Well, on Greece, as you're well aware, we fully recognized the loss over the last few past quarters. And the current quarter, we physically settled it.

So we can happily say we have no exposure to Greece going forward. We have no contingent liability. Everything has been paid for, done and reflected through the financial statements.

In terms of Spain, as we said, we have no real, what I'll call, sovereign exposure. We don't have any government direct exposure.

However, we have a couple of deals where the sub-sovereigns, or the regions, do rely on the central government for some level of payment. Principally, we have a toll road that basically gets paid a shadow toll. There's no tolls collected on the road, but they get paid a shadow toll.

That ultimately comes through the regional government, but, of course, the regional governments are typically supported by the central government. And we've taken a very conservative view, and everyone has an opinion on Spain, and I'm sure, Larry, if I ask you what yours is, it's probably different than a lot of folks.

So we did internally downgrade it, and once we downgrade something, then we have to put it through our loss filtering system. Once we do that, then we've got to come up with our scenario analysis, and put probability weightings on that. And, ultimately, it resulted in us putting in loss reserves for both a convention center in Valencia and this toll road.

Okay, all right. Thanks for the color on that.

(Operator Instructions) Brian Meredith, UBS.

Just a quick one here. So, can you give us a sense of what you think the pipeline looks like for you guys, in the event that Moody's decides to keep you at your rating level? What do you think the potential PVP opportunities are here?

It's a tough question. So we're really on the far end of the diving board here, but A, as we go round the market, there's a lot of views that says the market has already anticipated a downgrade. Therefore, I would assume that we maintain current underwriting levels. There'd be a reasonable uptick in opportunity.

More importantly, though, it's just the ultimate coming to a decision. I think the uncertainty is the thing that cost us more opportunities and especially in the international markets.

We're there. We've had so many really good opportunities scheduled, and we're in very good active discussions, and yet there's just this hesitancy to ultimately commit and then close, because of the uncertainty. And saying okay, you've got a falling knife. How far does it fall?

So there's a big school of thought that says if it's already priced in, in certainty, then resolve this issue once and for all. Because, as I look at our portfolios, I look at the general economic recovery, I would -- of course, I'll be wrong, but I'll go on record saying that I would not anticipate another review for potential downgrade ever crossing our door, because everything is going in our favor.

And then you put some rep and warranty settlements out there, and this thing becomes an absolute no brainer, from the standpoint of, what is the financial strength of this Company?

So, if I'm going to be right that this is the last time I'm ever going to have to face this in my career, then certainty's got to add some value to it. Certainty's got to really then stabilize the markets so that, okay, we're very comfortable with the Company. We've now resolved this question. Where it's more, I won't say cosmetic, but it's more a view, as opposed to a real reality of the financial strength of the Company.

So I think, either way, we get a benefit. If we retain, I think the benefit could be substantially stronger. It's hard to earmark a number, because the other thing, Brian, is you appreciate we're still fighting a zero interest rate environment.

And, therefore, where spreads are, where interest rates are, the typical municipal issuer today is issuing anywhere between, say, 40 and 80 basis points below what we would have insured it down to in the heyday of our AAA financial strength.

So you're able to go out and issue cheaper than you ever have historically, even with the provision of bond insurance, back in our best marketing days.

But it gets rid of this concern that says, okay, you're under a rating watch. Let's see what the rating watch ultimately results in.

Got you. And then second question, wonder if you could talk on a capital management perspective. Now, once we get through Moody's, what are your thoughts, I think, on capital management? And maybe what is the available funds you have for capital management?

Well, as you know, the structure of the Company, available funds really have to be located in the holding company, in Bermuda, and getting money to the holding company has its own limitations and restrictions.

We look at capital management, as we have from the beginning of time, which is, first and foremost, to maintain the highest ratings that are available to our business and our industry to allow us to transact what we think is still a very good market. And the market has shown its resiliency. It's shown its profitability.

Here we are once again reporting a very good quarter for earnings. We have a lot of ways that we can create earnings in the Company, and that's something that we value and we think it's a real value to the shareholders. So, first, we've got to resolve that problem.

And, as you well know, we have a current review still outstanding that has not assessed our capital, and, therefore, we're waiting to hear that.

I think, once we get the capital assessment, that gives us a good then first part of the equation which says what is the capital necessary to maintain ratings?

And then we've got to look at capital management. And capital management says, what's our expectation of the market and the market opportunity? How much capital do we need to be in that marketplace? Other uses of our capital like buying back our ensured bonds; you have to assess that part of the market.

So we have continued to assess market opportunities. Matter of fact, we just went through our business plan with our Board of Directors, which they approved. And, in there, there is about three or four components as to how it looks at capital usage, and, therefore, once you get through that, you then have your view of what the capital position is.

And, obviously, our goal is to maintain value for both bondholders and shareholders, and we've got a --- that affects strategies that achieve that.

Right. And, I guess, just as a follow up, what is the current liquidity at the holding company? And what, at the end of the quarter, was the dividend capacity out of Assured Guaranty Re?

Current liquidity in the holding company is about $225 million. And Assured Guaranty Re, as you know, also holds in trust for the benefit of its policyholders, primarily AGM and AGC, a significant amount of its assets. So AG Re has unencumbered assets of approximately $190 million to $200 million.

Great. Thank you very much.

Bill Clark.

You talked about bondholders coming to your door in the secondary market and potentially that leading to a better pricing environment. Could you just talk about that a little bit more? Is that as impacted by the low rate situation, low spreads? Or how do you compare that to where we've been in the secondary market in years past?

Well, it's a good question. So, the first thing we did, and we actually have prepared schedules, and both rating agencies have them, that the actual premium rate we get today for insured par is higher than what it was in, what we'll call, the heyday, the 2006/2007 period of bond insurance.

So, because we're trapping a lot higher percentage of the spread, then, obviously, in light of the fact that we're the only guarantor out there, it gives us that opportunity, premium rates are actually higher.

Typically, the secondary market rates are substantially higher than the primary market, and that same equation exists today. Because, as I said, the decision on the secondary market is, I'm not trying to convince you to buy insurance. You're asking me to sell you insurance, and it's a very different equation.

So, we continue to look at rates. That's one of the critical things. You say, okay, if I put capital to use, I'd better make sure I'm putting it to use with a reasonable return expectation, or a proper value to the product that we're selling, in both cases, secondary, as I said, substantially higher than primary.

We can probably get you some exact numbers in terms of the significant increase between secondary market and primary market, but it still maintains the same relationship that it did in the past. And what I'll tell you is we get a higher average rate to par today than we did in the past.

But, just to give you full information, one of the interesting things, where the interest rates are so low today, affects ultimate debt service. And, remember, our premium rate is against ultimate debt service.

So just alone on the low interest rates, the premium we book when we do a PVP calculation has been significantly impacted. So, even if everything else was the same and we issued the exact same amount of par as we did in the past, you would still see probably around a 20% decline in reported premiums, just because of the debt service change.

Okay. That's very helpful. Thank you.

Raffi Tokatlian, Bridger Capital.

I had a quick question. I believe in the third quarter you guys had discussions with your New York regulator on potentially freeing up collateral with reinsurance transactions with AG Re, and I wanted to know if there was any kind of update on those discussions.

There's really no update on the discussions, and I'm getting -- heard from our General Counsel. Have we had discussions?

We have routine discussions with the New York Insurance Department; they are ongoing all the time.

Yes, well Raffi, it's not collateral per se, right? But as part of New York State insurance regulation, you have to post these contingency reserves, and to the extent that you cede the business then the reinsurer has to post the contingency reserves, which encumbers their capital.

On a regular basis, we go back and try to identify transactions that have expired where we're theoretically still applying. Because the contingency reserves builds up over a period of time and then decreases over a period of time. And, therefore, we go to the New York Department and specifically identify the policies that have expired, and ask for the release of the contingency reserve. And that's an ongoing process.

And we've got some other things on the table with New York. As we get those approvals, we'll let you know.

Okay, thanks.

Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Robert Tucker for any closing remarks.

Thank you, operator. I'd like to thank everyone for joining us on today's call. If you have additional questions, please feel free to give me a call. My number is listed on the press release. Thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.