Assured Guaranty Ltd (AGO) 2013 Q2 法說會逐字稿

Good morning, and welcome to the Assured Guaranty Limited second-quarter 2013 earnings conference call and webcast. All participants will be in a listen-only mode.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Robert Tucker, Managing Director, Investor Relations and Corporate Communications. Please go ahead.

Thank you, operator. Good morning, and thank you for joining Assured Guaranty for our second-quarter 2013 financial results conference call. Today's presentation is made pursuant to the 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, launch 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're listening to a replay of this call or if you're 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, and for the risk factors. In turning to the presentation, our speakers today are Dominic Frederico, Chief -- President and Chief Executive Officer of Assured Guaranty Limited; and Rob Bailenson, our Chief Financial Officer. After their remarks, we'll open the call to your questions. As the webcast is not enabled for Q&A, please dial into the call if you'd like to ask a question. I will now turn the call over to Dominic.

Thank you, Robert, and welcome to everyone attending today's call. I'd like to start the call by discussing two important developments that were part of our 2013 three-pronged, new strategic initiatives. First, we increased our capital flexibility by obtaining permission from the Maryland and New York insurance regulators for our direct financial guaranty subsidiaries to reassume contingency reserves previously ceded to AG Re. And, secondly, we launched MAC, the new municipal bond insurance platform we promised in January.

To my first point, AGC and AGM expect to reassume the contingency reserves from AG RE over a three-year period. The re-assumptions permit AG Re to reduce collateral that was required to secure its reinsurance liabilities to AGC and AGM by approximately $171 million in 2013 and by $517 million in total over three years. Additionally, AGM and AGC will not see contingency reserves to AG Re in the future. The re-assumptions have no impact on the statutory capital or rating agency capital of AGC and AGM, as the contingency reserves are considered part of statutory capital of each company.

The second important development was the launch of Municipal Assurance Corporation. MAC is intended to expand market demand for bond insurance by appealing to issuers and investors who prefer a bond insurer with exposure to only the most familiar and well-understood types of US municipal bonds, such as general obligations, tax-backed issues, and public electric, water, sewer and transportation revenue bonds. MAC's profile is unique in the industry. It starts out with $111 billion of 100% investment-grade, geographically diversified portfolio of US municipal bonds, which is reinsured from our two other US subsidiaries, AGM and AGC.

In addition to ceding business to MAC, AGM and AGC have provided approximately $800 million in cash and securities to capitalize the new company and become its joint owners. As a result, on day one, MAC launches a fully functioning bond insurer with $1.5 billion in claim paying resources, including a $709-million stockpile of unearned premiums, which means it is already generating significant income and has substantial liquidity. It is important to understand that MAC does not have the start-up risks and expenses you would typically associate with a de novo company.

It has been profitable from day one and shares the proven public finance underwriting, surveillance and legal resources that AGM and AGC have developed for over 25 years, as well as our well-established information technology and financial reporting infrastructure. Furthermore, MAC is the only truly active bond insurer with a AA-plus rating by a nationally recognized statistical rating organization. MAC is rated AA plus by Kroll Bond Ratings and AA minus by S&P. Both ratings have stable outlooks.

Separately, I'd like to mention some positive news from our European subsidiary, where for the first time since the global financial crisis began, UK public-private partnership financings have been funded in the capital markets. What made it possible was our guaranty. This marks the return of the pre-crisis model for funding infrastructure in the bond market. Our [rate] provides not only credit enhancement to meet investor risk guidelines but also informed credit analysis and diligence at our origination. And the long-term surveillance is central for these projects.

We guaranteed two UK PPP issues in July, a GBP102-million PFI bond to finance a redevelopment project in Leeds, and a GBP63-million financing for the University of Edinburgh student accommodations. These transactions will be reflected on our third-quarter results, and we are optimistic about other transactions of this type in our pipeline. All these positive developments reflect our ability to adjust to changing market conditions, such as the current low interest rate environment and the slow recovery of the financial guaranty insurance market. In the same vein, we have continued to focus on our alternate strategies of share repurchases, rep and warranty recoveries, exposure terminations and reinsurance recapture to enhance our shareholder value. So far this year, we have continued to generate significant success in most of these important areas.

Focusing on the second quarter, we finalized two RMBS rep and warranty settlement agreements relating to $367 million in remaining net par outstanding. I spoke at some length on our last call about one of these, a settlement with UBS, which gave us an initial cash payment of $358 million and the benefit of a collateralized loss-sharing reinsurance arrangement for future losses. We subsequently fully settled our rep and warranty claims with Flagstar. In addition to receiving $105 million cash payment from Flagstar, we'll be further reimbursed for future RMBS claims in our Flagstar transactions. Also in the quarter, we agreed to terminate 35 policies totaling $2.6 billion of net par outstanding while receiving 100% of the expected premiums. These positive results were offset somewhat by an increase in loss reserves, mainly associated with our Detroit exposure.

Regarding new business, we've said that demand for insurance will improve as interest rates increase. We saw evidence of that after rates increased in June. As market conditions improve, we will be well positioned with our multiple platforms to meet issuer and investor needs. That said, overall US municipal production, both par written and PVP, were down versus second-quarter 2012 results, partly because market volume was down 22% from last year. For the industry, however, municipal insurance penetration was higher in the second quarter than in the first, moving up from 2.6% to 3.9%. It also moved from 8% to 14% for single-A credits, so there are positive indicators in terms of future demand as interest rates rise.

Of course, the biggest municipal news in recent weeks concerns Detroit, the largest US municipal ever to seek bankruptcy protection. Most of our Detroit-related exposure is to revenue bonds of the water and sewage disposal systems, which provide essential services to areas that extend significantly beyond the city limits. These cities are -- these services are essential to the state of Michigan, serving, respectively, 38% and 28% of its population.

Wholesale purchasers outside Detroit generate 70% -- 77% of the water system operating revenues and 56% of sewage disposal system operating revenues. Both systems are cash flow positive and, in fiscal year 2012, net revenues covered debt service on the first- and second-lien bonds of the water and the sewer systems comfortably. Since these obligations are secured by liens on special revenues and the systems are cash flow positive, timely payment of debt service should be insulated from the financial difficulties of the City of Detroit.

We also have exposure to Detroit unlimited tax-obligation bonds. The city voters approved the debt and the bond resolutions unequivocally and irrevocably pledges the city's full faith in credit, unlimited taxing power, and the resources of the city for the timely payment of principal and interest. Our G.O. ULT exposure is $146 million in net par, with an average annual debt service amount over the next 10 years of $15.3 million per year. We believe the city's pledge of its unlimited taxing power and resources is not legally or morally on the same level of priority as unsecured obligations to vendors and other creditors.

Lastly, through reinsurance, we have $175 million in net par exposure to general fund obligations of the city for which the average annual debt service over the next 10 years equals $12.4 million per year and, since this is a reinsured exposure, we will follow the fortunes of the primary insurer in their settlement discussions. As we see certain municipalities encounter financial difficulties, mostly resulting from their own actions, it is very concerning how quickly they attempt to transfer the burden of their decisions and seek remedies from parties that will not resolve their long-term financial issues.

Also, how do we evaluate the moral compasses of our public officials or their nominees when they are so willing to ignore pledges or commitments that they have made and that have been honored for years and, furthermore, that form the foundation of how capital markets provide necessary funding to municipalities? How can public officials be trusted to honor any of their other pledges to citizens if they can so easily ignore obligations that were voter approved and recommended by them or their predecessors and provide essential support to the municipality?

The long-term consequences of pursuing such a strategy for the citizens of the city and its state are likely to be costly. They include the reduced ability to attract new business and residents as well as to provide for the maintenance and improvements to infrastructure that are necessary to maintain its current services and encourage new investments. None of these things can be initiated by a city caught up in operational failure and bankruptcy.

Finally, Michigan has already started to see the impact of some investment-grade borrowers have found it necessary to increase yields, and three have announced that they needed to delay expected bond offerings. Given the pressing need to maintain, upgrade, and expand the nation's public infrastructure, it is unconscionable that a few elected or appointed public officials were would pursue policies that would weaken confidence in the bedrock principle of public finance that has been built over decades and provides a valuable resource to all municipalities. As always, we will continue to honor our insurance commitment to our Detroit policyholders. We will also continue to enforce our rights to compel Detroit to honor its pledges they made to induce the capital markets to extend their credit.

Negotiated settlements can be challenging but are achievable. An example is the conditional agreement announced in June and approved in federal bankruptcy court this week which provides a framework for resolving Jefferson County, Alabama, sewer indebtedness. I'll conclude by saying that we are optimistic about the future, especially as interest rates rise. With Europe coming back online, and MAC and AGM positioned for continued leadership in the municipal market, as well as AGC's ability to execute selected high-quality structured financings, we are well equipped to serve our markets while managing our capital efficiently. I will now turn the call over to Rob.

Thank you, Dominic, and good morning to everyone on the call. Operating income for the second quarter of 2013 was $98 million. This brings our year-to-date operating income to $358 million, which is a 94% increase over the six-month period at June 30, 2012. Second-quarter 2013 operating income was lower than second-quarter 2012, largely due to the scheduled amortization of the insurance portfolio and lower premium accelerations, offset in part by reduced losses and other expenses.

On a year-to-date basis, operating income benefit from various settlement agreements, including UBS, while 2012 reflected losses on Greek exposures. On a per-share basis, operating income was $0.52 for the second quarter of 2013 and $1.87 on a year-to-date basis. During the second quarter of 2013, we repurchased 9.6 million shares at an average price of $21.42 per share, bringing our year-to-date repurchases to 11.5 million shares, or $244 million. On a per-share basis, our share buyback added $1.65 to adjusted book value, $0.66 to operating book value, and $0.20 to GAAP book value. Share repurchases added $0.02 to second-quarter operating income per share and $0.04 to our year-to-date operating income per share. We have $71 million left in our current share buyback authorization, which we will use at our discretion.

One of the most important drivers of our ability to execute future share repurchases is the level of unencumbered assets at AG Re, our Bermuda reinsurance subsidiary, which is the primary source of cash for the holding company. As of July 31, 2013, AG Re had unencumbered assets available for dividends of approximately $280 million. However, the amount of unencumbered assets varied each quarter based on changes in both the amount in ceded reserves and the fair value of the underlying assets in the reinsurance trust.

Our exposure to Detroit pension obligation bonds was assumed by AG Re from a third-party ceding company, and we expect that unencumbered assets will decline in the third quarter of 2013 when we pose additional assets to the trust accounts, as required by our reinsurance agreements. As a general rule, trust accounts are adjusted on a quarter lag to allow the ceding companies to finalize their calculations and report their balances to us.

Premium accelerations due to refundings and negotiated terminations of insurance and CDS contracts were $60 million in the second quarter of 2013, consisting of $31 million in negotiated terminations and $29 million in refundings of public finance transactions. This compares to a total of $69 million in accelerations and terminations in the second quarter of 2012. On a year-to-date basis, accelerations and terminations were $174 million, which represents a 64% increase over the comparable period in 2012. In addition to the immediate benefit to operating income, terminations and refundings have the added benefit of deleveraging our capital and increasing the rate at which excess capital is released. This is reflected in the 10% decline in statutory-to-net-par-qualified statutory capital ratio, which went from 84-to-1 at the end of 2012 to 76-to-1 at the end of June 30, 2013.

While low interest rates provide an incentive for municipal [issuers] to refund existing bonds and thereby accelerate premium revenues, the flip side is that they lower reinvestment rates in our investment portfolio. This has caused a slight decline in net investment income from $97 million in the second quarter of 2012 to $94 million in the second quarter of 2013. The overall pre-tax book yield was 3.81% at June 30, 2013, compared with 3.88% at June 30, 2012. Economic loss development was $87 million in the second-quarter 2013, primarily reflecting losses from Detroit and RMBS transactions, partially offset by positive development in other sectors.

Second-quarter 2013 operating expenses were $52 million, which was relatively flat compared to the second quarter of 2012. For each of the remaining quarters of 2013, I expect operating expenses will be between $50 million and $55 million. Interest expense was down $4 million, to $21 million, due primarily to the redemption of the equity units in June of 2012.

The effective tax rate on operating income was 29.4% for the second quarter of 2013 compared with 29.9% for the second quarter of 2012. The relatively high effective tax rate for the second quarter of 2013 and 2012 was due to operating losses in AG Re during these periods. On a year-to-date basis, the effective tax rate on operating income was 26.8% in 2013 and 25.7% in 2012.

Adjusted book value per share increased to $49.06 from $47.17 at December 31, 2012, primarily due to the share repurchase program. Operating shareholders' equity per share increased on a record -- increased to a record $32.45 from $30.05, reflecting the impact of the share repurchase program and year-to-date operating income. I'll now turn the call over to the operator to give you instructions for the Q&A period. Thank you.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

At this time, we'll pause momentarily to assemble our roster. Geoff Dunn, Dowling and Partners.

First, could you comment -- the ratio of PDP to par dropped off significantly this quarter. Can you discuss what drove that? It didn't look like the average rating changed that much.

No, but it really does break down by issuers in terms of who was in the market and obviously, the rates and spreads at the time. So it's more reflective of the type of business and the current market conditions than anything else, Geoff.

Would that be expected to rebound in the third quarter or with the rates changing, et cetera, are we looking at a lower run rate there?

I think we'll rebound as rates change and spreads widened, which we've seen a little bit of that at the end of the quarter.

Okay. And then, could you again explain what you expect to happen to AG Re's unencumbered assets? I didn't quite fully understand that. The third quarter impact you said, I think, do you believe is going to decline?

Geoff, we have about $280 million of unencumbered assets at AG Re. We also have $47 million at the holding company. As you know, AG Re is a significant supporter of the dividends to the holding company for our equity dividend. And AG Re did assume the $175 million of pension obligation bonds from Detroit that Dominic mentioned from a ceding company.

And as required under our reinsurance agreements, when we are ceded a loss reserve or sent a loss reserve on a Board [G. O.], we are required to put those assets in trust. We are expecting to be ceded a loss reserve on that obligation. We just don't know the number at this time.

The second thing, Geoff, too, is remember these are collateral trusts that are represented by securities. So as interest rates change and the valuation of those securities change, it requires us, in a rising interest-rate environment, to top up the trust, obviously, in a declining interest rate environment with a fixed income portfolio, you'd see gains in the portfolio. So both of those are kind of a drain on the free assets and we have to anticipate and try to plan for quarter-to-quarter, making sure we still leave enough cushion to pay the necessary dividend expenses, et cetera, at least for the time being, while we still rely on AG Re as the principal source of cash flow to the Parent company.

Okay. So from a high-level, you guys have been very aggressive with returning capital to date. You've made progress on capitalizing MAC and restructuring AG Re this quarter. How will we think about the pace of capital return if you still find the stock attractive? Is this something where we are running into a slowdown in activity or do you think your resources will continue to support a good clip of repurchase business?

Remember, we had a strategy to address this, right? So first and foremost, we look first to our ratings and make sure that anything we do relative to the return of capital has no impact on rate. The second thing we have to do is look at the liquidity or the free unencumbered assets currently at AG Re, right? As we said we had a three-pronged strategy. We accomplished two of the three in the quarter, the launch of MAC and the restructuring at least from a contingency reserve and reinsurance part with both New York and Maryland.

We still have the third component of the restructuring, which we didn't refer to in the quarter because it hasn't been completed yet. There are some administrative issues and issues relative to global regulations that have to be resolved, and we hope to get them resolved in the near term, which would then take the pressure off of AG Re. So in the meantime, we have to look at AG Re, manage accordingly, as Rob said, the available or free cash flow. And obviously, maintain our ratings. And then to the extent we have the free cash flow and when we are comfortable with the ratings, provide that as part of our official capital -- efficient capital management, which is absolutely the return of capital to the shareholders.

Sean Dargan, Macquarie.

I just want to follow-up on what Dominic was just talking about the third component and it sounds like global regulators are involved. Can you give us any more color on what form this may take to enable you to not have to pay the withholding tax in bringing capital out of the US?

I think you can follow that lead, right? So we said it involves a restructuring; we said it involves regulators' sign-off and approval. And as we're ready to announce exactly, but we've decided -- we've obviously chosen the strategic direction. We've done the majority of the required applications, et cetera. We are now in the final stages of just resolving some open issues relative to basically administrative and global regulation which we hope to finally resolve in this quarter. And as we get that done, you can figure that it involves a restructuring, and therefore provides greater liquidity of capital through the entire organization.

Okay. Thanks. And the news still out of Detroit has been pretty steady and sometimes confusing. Can you just tell us where -- this -- I guess there's a federalism issue. Can you just tell us where this stands in terms of the state court and how it looks like it's going -- how this proceeding is going to go forward?

You're basically in untested waters. Right? So historically, the full pledge of taxing resources or taxing authority, full faith and credit and resources has typically been considered secured and always has been worked out as opposed to eliminated or written down. Obviously, the early indications out of Detroit was they were not going to honor that. They were going to treat the ULT bonds, or the tax-backed bonds, as unsecured creditors. And a lot of people quote, well, this is protected by the state constitution, such like retirement benefits, and we'll sell the bond obligations.

And the tricky part here is, as you apply for bankruptcy, you're now in federal court, not state court, and therefore the state constitution would typically be secondary to the federal. Federal trumps state, typically, in a federal bankruptcy proceeding, so that is where the confusion lies. We look at it on a broader basis as, hang on a second, this full faith and credit pledge is not a promise. It's a pledge. You commit resources, the taxing authority, et cetera, to make sure that these obligations are met and we don't consider that an unsecured credit.

Number two, there is an enormous impact not only to Detroit, but especially to the State of Michigan to the extent that the governor and the legislature do not support the position of basically the people that provide funding for valuable infrastructure needs and expansion, et cetera, to those municipalities if you're going to consider them not protected. So there's an issue of federal versus state. There's an issue of what has historically been treated as secured, what the true foundation if you read the language, it appears to provide that lien position. And yet, Detroit has chosen a different way, and I think what you've seen recently, at least in the market, is the market's reaction.

Obviously, there have been three cities that had to pull back bond offerings because it was either going to be executed at a cost that they couldn't accept or could not get executed at all. And that's the reality of life. So like anything else, if you as an individual default on credit, trust me, you're going to have a tough time getting credit and for all the right reasons. You can't go out and make these unequivocal and irrevocable pledges and pretend like they don't exist, right? Especially where these are people that are providing you valuable resources that allow you to do the investment that is going to be necessary to turn around any economic situation.

And as I said, my biggest issue is where the moral compass of these elected officials that say, yes, we have the obligation and especially if you look at Rhode Island, when the Studios 38 bonds, you had a Senator up there that said yes, we have the money, we have the obligation, you know what? Let's just walk away from it. Well, I have a real problem with that. And it says, what is this person all about and how do I value anything this guy says or this individual says as being reasonable or something I can count on?

So if I'm the citizens of these areas, say, well, how do I rely on a guy I just elected if he immediately turns around and revokes all responsibility relative to what is a very strongly worded and provides extreme value to the municipality of these commitments? So Detroit's going to play out over a long period of time. It's really started off kind of in a situation that has not been tested. Again, we feel comfortable with where we're at relative to our exposures and how this thing ultimately plays out. But the whole concept that you're referring to is this difference between federal law and state law.

Brian Meredith, UBS.

Couple questions here for you. First, I'm wondering if you could give us what's your total certificate of participation at par exposure is? And then how much of that is below investment grade?

For Detroit or for everybody?

Every -- just in general. Get a sense of what it's like.

Well, I don't have that number off the top of my head. Obviously, we list all of our large exposures. We list all of our below investment-grade exposures. We did look at that, Brian. I just don't have the number with me.

Okay. Great. I'll follow-up on that one.

We'll endeavor to release that --

And get back to you.

Great. Thanks. And then just a second question. I'm just curious, Dominic, have we seen any change in the pricing in the market given the BAMs out there now? Is it effective pricing at all?

Well, you're seeing obviously a running out of spreads, so you're starting to see pricing change. Obviously, you're seeing it for Michigan because people said well, it's a national problem. My view is no, it's a Michigan problem. Because certain states do stand behind the financial efficacy of their municipalities. So I think, you look at what Rhode Island did, you look at what Pennsylvania did, but I think in certain places, yes.

For us, we have to look at our underwriting and our risk acceptance. So you brought up the general fund liabilities like pension certificates. Well, obviously, we're no longer into that business. So anyone that was looking at that as a potential source of being able to fund those liabilities because of how Stockton has tried to treat them, how Detroit's tried to treat them. Obviously, they become no longer underwritable for us and therefore, those things are going to have a lot tougher time getting place in the market, if at all, and if so, at what price do they get placed in the market?

So I think everything -- like anything else in any business, your pricing model has to take in consideration all costs and as the risk cost goes up, the pricing model has to accommodate for that. But in our case we really do write to a zero loss ratio. Right? So at the end of the day, that becomes a risk that we can no longer do.

(Operator Instructions)

Bill Clark, KBW.

Dominic, you mentioned a couple of deals that ended up getting postponed, and you also said it was maybe just a Michigan-only problem. But I'm just wondering if you've seen any movement towards your industry in terms of potentially being able to provide some solutions there, or enhancements that would help get some of those deals completed?

Well, that's a good point. Typically, we would look to provide valuable services and the access to the market, but we have to be in a secured position. So obviously, anything that we would propose has to protect the Company first and foremost. Obviously, underwriting this job, one, two, three and four. And therefore, if they're willing to come back to the market in some secured position, a dedicated revenue position, obviously, we'd be available to help them.

Okay. And then on the refundings and terminations, it's come down at a pretty quick pace the last couple quarters. Just wondering if we've hit a level that you think is sustainable for the near-term? Or just depends on the interest rate movement and those things? And it's just going to bounce around from here?

Well, as you look at our strategy for 2013 and it was just similar in '12 and '11, right? It's obviously less reliant on new business because of where interest rates are and spreads are and overall demand, which we see improving a bit towards the end of the quarter, as I said. But over these last few years, it's been very low, so you're going to have to make your money a different way. So we've concentrated on that and warranties and I think we've been the most successful Company in pursuing that strategy and generating significant positive results.

We looked at the terminations as both an earnings benefitor because you get to recognize the premium at same time you're deleveraging the Company, and therefore creating excess capital. Those things don't move uniformly, so therefore, income is going to be lumpy and as you look at our quarter, it's below consensus. We might argue that people didn't quite factor in Detroit to the level they should have, but it's because we had so much accelerations and recoveries in the first quarter, and you don't see that same amount of volume. But we still believe there is a lot of activity and opportunity remaining in the portfolio, at least as we look out over the next say, 12 to 18 months. And we continue to focus a lot our resources on exactly the execution of that strategy. And today, it's a lot more focused.

We think it will be further assisted as these new capital rules take further hold in Europe, specifically where we do have a lot of counterparty exposure in Europe. They are going to need to start to manage the capital exposure differently, and therefore, they might want to terminate furthers deals that we target. At the same time, we're negotiating settlements where we're dealing with the counterparty and it might be on a RMBS issue where we had to have other exposure with them on a CDS that we tried to work everything into a single bundle of in effect, a remedy to solve the problem. And you've seen a little bit of that in the current quarter, so I think there is still volume out there to be had but the numbers are going to be lumpy so it's hard to predict quarter after quarter in terms of what a number would be.

Scott Frost, Bank of America Merrill Lynch.

I'd like to talk about Kroll a little bit. Kroll, it's a three-year-old NRSRO, run by Jules Kroll but not affiliated with Kroll Inc., that Marsh bought and sold? Why do we believe that investors and issuers will accept Kroll as an alternative to Moody's or Fitch?

Well, I think the market has been looking for alternatives to the existing incumbents based on, obviously, the problems that have been experienced through the financial crisis with the stability or inconsistency of ratings. Obviously, we believe we are a poster child for that inconsistency.

And there are some really interesting numbers, if you look at our numbers as of January 1, 2008, and January 1, 2013, and if you don't conclude, we're a lot stronger Company over that period of time, I don't know what else you could conclude. Yet our ratings are obviously significantly different than that.

But first and foremost, Kroll's been very transparent in their approach to how they rate and their rating methodology which is out there for anyone to see. So one way you get comfort is you make sure people understand how you approach things and are very clear and transparent about it, which they've done.

I think they've been very thorough and the credit work they've done. On the municipal side, for the municipalities, they've rated I think they've put out a very, very strong reports. I think the report that they did on us following their own methodology was obviously very complete and thorough.

So they have a very experienced team, if you look at the people that they employed. And as I said, I think the market is looking for someone that's going to be consistent, transparent, and stand behind the rating and the methodology/ And if you look at the Kroll approach, it's very much deeply embedded in financial strength. And since these are called our financial strength ratios, they really should look to what is the probability of a potential default.

And obviously, the lower the probability, the higher the rating. I think they've basically stayed to that, admitting, which is, I think, how you have to look at financial strength ratings. If you want to talk about enterprise ratings more on an equity basis, then fine, you have the right to make any subjective adjustments you want. But if you're looking at financial strength from the standpoint of an investor bondholder that says, will I get paid my timely principal interest?

That's the most important thing I have to concern myself with. I think Kroll has stayed close to that faith, that religion in how they look at ratings, so I think there's an opportunity for them. As I said, transparency is king. Clarity is king. And they've taken a consistent approach and we're happy to have them, and we obviously welcome other people coming into the market that come in on the same type of basis.

Well, that's -- and that's the other thing that stuck out. Most of the personnel there look like they are former rating agency guys from S&P and Moody's and Fitch --

I hate to tell you a lot of our guys are exactly the same way. There's kind of a training ground --

That wasn't a criticism. I was just -- that's a fact. I mean, it was a -- but what I'm trying to say --

You can make it a criticism. I'm okay with that, as well.

(laughter) So what I'm trying to figure out is, it sounds like what you're saying is, this is -- you think this is a better process than Moody's or Fitch and that's why you chose it? What I'm trying to figure out is, have -- has the feedback from issuers and ultimately investors been yes, I will accept a lower rate on a wrapped bond because I believe Kroll's ratings versus, say, Moody's or Fitch, or versus an unwrapped bond? Has that been -- what's been going on or what's been the color so far?

Well, I think you need to talk to them. But, more importantly about how they believe their market penetration is. But obviously, they've been new to the game. It takes a while to generate critical mass. I think they've been very successful in what they've been able to rate to date. And we can only, much like you, watch and see how strong the acceptance is, how wide their acceptance becomes as they get to rate more things. I think we look at that as a true value to get in on the kind of ground floor and as it grows, get the benefit of their growth. I'm sure with Mr. Kroll's success, that he's going to put the right resources and make sure this is successful as any of the other ventures that he's done, and we're happy to be a part of it.

Josh Bederman, Pyrrho Capital.

Can you -- on the fourth quarter call you gave an estimate of $800 million of excess capital above your AAA rating. Can you update that estimate for where we are now at June 30?

Well, the only one that we look at that has given us a capital model that we can actually calculate is Standard & Poor's. And as of their most recent rating, I think they evaluated us with either $500 million or $600 million of excess capital. There are still some questions that we have relative to that capital calculation. There are some strange numbers on RMBS that we'd like to get a further explanation. But I think that's the last number that's been communicated.

Okay. Thanks. And then just one more thing. You said there's about $47 million of unencumbered assets at the hold co., $280 million at AG Re, but that might go down. You're working on the structural changes here. So what else -- what do you guys look at as the unencumbered assets that will be available post the finalization of all the administrative stuff with the restructuring?

Well, that number is going to be significant because remember, you pay -- from my comments, we got roughly $170 million of contingency reserve released in the current period. However, there's an agreement that AG Re will no longer have to post any contingency reserves, and that number in the aggregate, including the $170 million, is $517 million. So our expectation is that over the next two years, the remainder of that gets released so obviously, that would provide significant free cash flow to AG Re.

And then -- no, go ahead.

In addition, we will -- we have two operating subsidiaries in the US. And we can dividend up to the holding company and assuming we get what want to get accomplished, that money could be used as well.

And what's that figure?

We -- I mean --

It's in the Q.

It's in the Q. We have a 10% -- you can dividend up to 10% of its [sector] surplus. And so that number is about -- I think it's about $200 million a year, both companies.

Larry Vitale, Moore Capital.

I just had a couple follow-ups. The $87 million of economic loss, can you break that down, Detroit, RMBS and then you said there were some recoveries in there, as well?

Yes, Larry, there's adjustments, or positives and negatives. The predominant charge in the quarter, though, is good old Detroit.

Okay. All right. Thanks, Dominic. And then the rep and warranty reserves -- or sorry, the rep and warranty cases that you're involved with; what's left? You've settled a lot of these things.

We still have some of the old boys left. So in the quarter, we settled two; we're close to a third. Obviously, the big boy was Credit Suisse, who's probably the most, in terms of par left. But then remember we told you we still have the swap side open with Deutsche Bank. We have the swap side open with Bank of America. We have a couple other small guys in there. So there's probably about three or four still left, of which Credit Suisse and the swaps of Deutsche Bank are the two largest.

Okay. All right. And my last question is the -- your $175 million reinsurance exposure to Detroit, do you expect to get loss reserves ceded to you? Do you have any idea how much that might be, if you could ballpark it for us? And then are you required to collateralize those on a dollar for dollar basis? So, if you get $100 million ceded to you, you have to put up collateral of $100 million? I'm just making that number up.

No, you're fine. So there's two questions in there. A, we have a view of what the losses were, right? In terms of how this will proceed. And obviously, we'll discuss that with the ceding company because we have the father fortunes. But to your latter question, you're exactly right. If they advised us of a case reserve, we'd have to post that amount of collateral, whether we agree or not agree with the amount of case reserve being advised.

This concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Tucker for any closing remarks.

Thank you, operator. I'd like to thank everybody for joining us on today's call. If you have additional questions, please feel free to give us a call. Thank you very much.

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