Assured Guaranty Ltd (AGO) 2014 Q1 法說會逐字稿

Good morning, and welcome to the Assured Guaranty conference call.

(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. And thank you all for joining Assured Guaranty for our first-quarter 2014 financial results conference call.

Today's presentation is made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The presentation may contain forward-looking statements about our new business and credit outlook, market conditions, credit spreads, financial ratings, loss reserves, financial results, future rep and warranty settlement agreements, and 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'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, President and Chief Executive Officer of Assured Guaranty Limited, and Rob Bailenson, our Chief Financial Officer. After their remarks, we will 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 joining today's first-quarter 2014 earnings call. Assured Guaranty has started the year with a solid first quarter, earning $132 million of operating income. We brought operating shareholders' equity per share to a record $34.45, and adjusted book value per share to $49.79.

Additionally, we resumed buying back common shares in March as part of our capital management strategy. Rob will bring you up to date on our share repurchase program in a moment. But first, I want to discuss some of the very positive recent developments at Assured Guaranty.

I will begin with the US public finance sector where we have had further success in resolving our exposures to troubled credits. Having reached a tentative settlement with Detroit last month on our limited tax general obligation bonds, after having previously achieved final or preliminary settlements with Jefferson County, Alabama; Harrisburg, Pennsylvania; and Stockton, California, we have significantly reduced the number of troubled credits in our insured portfolio.

In the Detroit settlement, we succeeded in defending a key tenant of municipal finance by requiring the city to confirm the secured status of the Detroit voter-approved UTGO bonds. I don't know whether any group of uninsured creditors could have achieved the same result, which highlights the significant value bond insurance brings to the municipal market. While the Detroit bankruptcy process is not yet over, this case should also serve as a cautionary tale for fixed-income investors, and reinforce the proposition that bond insurance provides significant benefit to insured bond holders.

In regards to Puerto Rico, the recent $3.5-billion offering provides needed liquidity as they continue to work through their fiscal and economic challenges. They have consistently expressed their intention to meet their debt obligations, and have taken positive steps to manage both their revenues and expenses. Last week, the governor introduced a balanced budget for 2015, a year earlier than he originally planned. We understand the Commonwealth will continue to face challenges for some time, and we will obviously be monitoring their progress.

Another area where we made great progress is in our legacy RMBS exposure. The size of our net US RMBS exposure is now less than half of what it was after we acquired AGM in the third quarter of 2009, when that exposure was over $30 billion and represented almost 5% of our insured portfolio. As of March 31 of this year, we had $13 billion of net US RMBS exposure, representing less than 3% of our insured portfolio. Of this exposure, more than 43% is investment grade.

Our claim payments have also improved. On a cash flow basis, our quarterly net RMBS claims have declined by 80% since their peak in the second quarter of 2012, and that is without giving effect to settlement or litigation receipts. By the end of the first quarter of 2014, average monthly claims paid before recoveries decreased to $19 million. And after subtracting recoveries, our monthly payments averaged less than $3 million.

Through putbacks, settlements and litigation, as of March 31, 2014, we have closed RMBS providers to pay or agree to pay $3.7 billion. This includes a new HELOC settlement reached in the first quarter with a regional bank. Currently 64% of our exposure to troubled US RMBS transactions relate to transactions that have benefit from rep or warranty agreements, including 35% in transactions that are covered by ongoing loss sharing agreements.

Among our rep and warranty providers, our principal outlier remains Credit Suisse. Earlier this year, Credit Suisse set aside substantial assets for contingencies like RMBS litigation. In February, a New York appeals court ruling reinstated our right to pursue broad remedies in addition to the repurchase of defective mortgage loans in our fraud and breach-of-contract action against Credit Suisse.

This case relates to RMBS with original par of $4.3 billion, of which we insured $567 million. We think it is in Credit Suisse's best interest to settle, as we have put back $2.2 billion of defective loans backing these transactions, which represents a claim that is a substantial multiple of Assured Guaranty's projected losses on the bonds it insured.

As a result of our various loss mitigation efforts and the ongoing deleveraging of our insured portfolio, we continue to improve our risk profile while also writing additional new business, and engendering an increasing positive market perception of our product and our Company.

Acknowledging all of this, on March 18, S&P upgraded the financial strength rating of all of our insurance operating subsidiaries from AA minus to AA flat; the highest rating they currently assign to any active bond insurer. Our new S&P rating should expand the available market for our guaranty, which brings me to the subject of new business production where our first-quarter PVP of $31 million was up 72% from a year ago. This is a good result, considering that low interest rates and tight credit spreads continue to limit opportunities in the US public finance sector. In fact, long-term municipal yields fell more than 50 basis points, and credit spreads tightened during the first quarter.

In addition, despite a 26% decline in total US municipal issuance in the first-quarter 2014 versus first-quarter 2013, we increased by 21% the par volume of bonds sold with our insurance. We think this improvement reflects greater awareness of the benefits of our guaranty, and the increasing market acceptance of MAC, our US muni-only bond insurer launched last July, which has the highest ratings from any nationally recognized statistical rating organization, a AA+ from Kroll. Through AGM and MAC, we continue to guarantee the majority of the municipal insured par sold in the primary market during the quarter. In total, including our strong secondary market business, we recorded $23 million of first-quarter US public finance PVP, up 44% from last year's first quarter.

In our unique position as the only guarantor with a diversified strategy across US public finance, international infrastructure, and structured finance, we are also now finding opportunities in Europe and the global structured finance market. In the United Kingdom, we guaranteed our 4th recent infrastructure transaction, a GBP77 million wrapped bond to finance a project to build and maintain social housing for seniors in the north of England.

Having now written business in three consecutive quarters, we are clearly gaining traction in the infrastructure market, and have a list of potential transactions, both in the UK and other countries. While we confidently look forward to further growth in our international business, as the recovery in Europe progresses, keep in mind that many of these transactions can take a relatively long time to execute, which can create variability in our quarterly international production results.

In structure finance, we're also seeing positive developments. In addition to two small transactions we closed in the first quarter, we have ongoing opportunities in the insurance sector and are seeing renewed interest in our participation in international future flow transactions. Last week, we closed a private transaction with a prominent insurance company, and we are currently mandated on two future flow issues, which are in process. We are optimistic about our opportunities in a variety of structured finance sectors in both US and international markets.

We also have opportunities in what I call production-like activities. This may include assumptions of other guarantors' insured obligations or re-assumptions of business we have previously ceded to third parties. For example, during the first quarter, we re-assumed approximately $850 million of almost exclusively US public finance, and European utility and infrastructure, par in exchange for the reinsurer's share of outstanding statutory unearned premiums plus a commutation premium. Thus, by taking the business back, we increase our unearned premium reserve and our future installment premiums, and also recognize the commutation gain.

Also during the first quarter, we continued to create value through alternative strategies, such as loss mitigation and capital management. Specifically, we bought $62 million of bonds we had previously insured for $53 million, or 86% of par. And we terminated or agreed to terminate $1.5 billion of net par outstanding. This included $790 million of commercial mortgage-backed exposure, thus eliminating 20% of our insured CMBS risk.

As far as the future is concerned, I am very optimistic. The reputations of Assured Guaranty and our bond insurance product are on the upswing. As our legacy RMBS issues fade, we remove uncertainties related to a handful of troubled municipal credits, and investors and their advisors take note of our ability to pay claims while maintaining or even improving our financial strength, something we have proven repeatedly.

We are the best-positioned guarantor in the US public finance sector, where we will have greater opportunities when interest rates rise closer to their historical norms. We believe the Fed will continue tapering its asset purchases, which should gradually push long-term interest rates higher.

Additionally, we see growing opportunities in the international infrastructure and structure finance markets. As we pursue all of our diverse opportunities, we will continue to manage our capital efficiently while maintaining the proven value of our financial guarantee.

Now I will turn the call over to Rob.

Thank you, Dominic, and good morning to everyone on the call. As Dominic mentioned, 2014 is off to a very good start, with $132 million in operating income, or $0.72 per share. I would like to highlight the operating income benefits of some of the developments Dominic mentioned, including $32 million related to R&W development, and $12 million in commutation gains from the re-assumption of ceded business, which also contributed a total of $38 million to pre-tax adjusted book value, and consisted of over $850 million of net par.

The first quarter also includes $20 million in premium accelerations, which vary from period to period. Economic loss development was $12 million in the first quarter of 2014, which was primarily due to our Detroit exposures and the effective changes in risk-free rates used to discount expected losses. This was offset in part by rep and warranty development, and improvements in other structured finance obligations.

The effective tax rate on operating income was slightly higher at 26.7% for the first quarter of 2014 compared with 25.8% in the first quarter of 2013, and was due to higher loss expense in non-taxable jurisdictions. When comparing operating income to the first quarter of 2013, it is important to note that 2013 included a $71-million benefit related to the R&W settlement with UBS, and premium accelerations of $64 million.

As of March 31, 2014, operating shareholders' equity hit a new high of $34.45 per share, and ABV per share rose to $49.79. In addition to PVP and re-assumptions, the biggest contributor to the quarterly increase in ABV per share has been our share repurchase program. As of today, we have used $75 million of our $400-million authorization. It is our intention to fully utilize the remaining $325 million by the end of September, and then to request another authorization from our Board. As in the past, our capital management execution is contingent on our available free cash and capital position, the maintenance of our strong financial strength ratings, and other factors.

Since January of 2013, we have repurchased 15.5 million shares at an average price of $21.90 per share, for a total of $339 million. As of March 31, 2014, the holding companies had cash and liquid assets of approximately $280 million, and we have dividend capacity from the US insurance subsidiaries of approximately $240 million that will be available to AGL throughout 2014.

In prior years, we relied solely on dividends from AG Re. Now that we have changed our tax residency, we will now also have access to the capital of our US subsidiaries.

Looking to the remainder of 2014, our financial supplement includes detail on our scheduled insurance revenues, excluding re-fundings and terminations, as well as loss expense. As we noted in our previous earnings call, quarterly net earned premiums and CDS revenues will be less than in prior years based on the amortization of par.

With respect to loss expense, we are pleased with this quarter's R&W development. However, we have fewer R&W providers left to pursue, and therefore, the benefit in the future may be less than in prior periods.

I'll now turn the call over to our operator to give you the instructions for the question-and-answer period. Thank you.

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

(Operator Instructions)

At this time, we will pause momentarily to assemble our roster. Our first question is from Sean Dargan from Macquarie. Please go ahead with your question.

Thank you. Just some unsolicited advice, please say that you are going to release before the open. I think the release gets out earlier than the night before.

When we look at the outlook for share repurchase, obviously there's -- I think you've made it clear that there will be no extraordinary dividend between now and September 30. Is there a possibility for that in 2015, now that you've got an upgrade from S&P? Does that change anything?

Well, I think as we look at the capital management strategy, and as Rob pointed out, it's based on a number of factors, and of course, you're pointing out the biggest one, which is the availability of free cash, we know and we've produced and disclosed the amount of normal cash that's available through the dividend capacity of our operating subsidiaries, and that will get us so far in the capital management.

So at some point in time, if we're going enhance that, based on, once again, our view of the ratings, stability and the financial side, position of the Company, we're going need to enhance it in some way, shape, or form. And one of the tools to enhance would be special dividend.

So we view that as an opportunity that's going to have to be realized or used, but obviously, as we look at the timing of it, we're being practical when we think it is going to be available to us from the New York point of view. And when that would be available, I think facts like upgrades of ratings would definitely help in our case to the New York and to the Maryland regulators.

Additionally, we're going look at other sources of potential additional free cash which would include potentially taking on additional debt. So all of those things will be evaluated as we look to buy back capital management view, the available cash generated from operating subsidiary dividend capacity, and enhance it where necessary by all other transactions that could theoretically be available to us, including special dividends.

Okay. Thank you. And just on the $23 million of gross total net economic loss development and public finance, can you give us any color as to what that was attributable to?

Most of that was attributable to developments in Detroit. As Dominic mentioned, we have agreed to some terms with the bankruptcy judge, and we have now booked up, based on our probability of weighted scenarios to developments related to Detroit.

Additionally, we did have the change in the risk-free rate which caused to us increase loss reserves across a lot of the exposures, and that discount rate change is for GAAP purposes. We'd have to change that and the expected cash flows, which has an effect on the reserves.

And that risk-free rate was primarily in structured finance, but that was about $27 million.

Okay. And how often do you revisit the discount rate?

It has to be revisited every quarter.

Okay. Thank you very much.

Our next question is from Brian Meredith of UBS. Please ask your question.

Thanks. Good morning. A couple questions for you, Dominic. The first one, any updates or anything you can tell us about Moody's and potentially what their thoughts are and do you think there's a possibility for an upgrade there?

You know Brian, I have a crystal ball, but the way it gets really dark when I put Moody's into the equation. All we know is what you know, publicly they have announced that they're looking at their methodology for any finishing reviews, or was supposed to, or going to publish a draft of comment in some part of this near future, and we have no expectation beyond that.

Great. And then next question. I'm just curious, with the ratings upgrade from S&P, does that increase the possibility at all that maybe you could find some portfolios in some of the other bond insurers moving your way?

Well, I think it makes the argument stronger, because obviously from the standpoint of the issuers, they stand to getting a more significant uptick from the higher rating being put on the security. Two, it creates a greater spread for us as we look at the value of our guarantee against a typical issuer in the marketplace. So I think it has two potential benefits there.

Got it. Any activity there?

We're always seeing activity, Brian. You know that. We're not wallflowers by any stretch of the imagination, so you understand that we try to talk to everybody we possibly can. We think it is a reasonable transaction that could benefit both parties in terms of freeing up cash for some of the existing guarantors in the marketplace, by providing them capital through parts of their organization where maybe they need it.

At the same time, we lower their risk and their risk exposure which further reduces their demand for capital. And then from the issuer or from the issuer on the investor side, obviously it's an upgrade to their outstanding securities.

Got you. And then, I'm just curious, with the ratings upgrade, have you seen any increase in the return on allocated capital earning you're seeing on your deals right now, or the spreads that you're achieving in the marketplace?

I'd say it's a little too early to tell. Obviously, there's a lot of information in the market, both positive and in some cases negative, when you think about Puerto Rico.

The guarantee or the upgrade came late in the quarter, so we expect that to really benefit future quarters. And as I said, as we continue to demonstrate the value of insurance, either by us protecting bond holders, negotiating on behalf of bond holders, or simply paying principal and interest when due, I think all of that continues to add to a very positive developing story for us.

Thanks.

(Operator Instructions)

Our next question is from Larry Vitale from Moore Capital. Please go ahead.

Hi, guys. How's everybody today?

Hi, Mr. Vitale.

Hi, Larry.

The unencumbered assets at AG Re have fallen now for, what, four quarters in a row. I wanted to confirm, if I have the number right, $238 million in Q4 down to $201 million here at Q1. What's the reason for the decline?

Good question, Larry. As we said, AG Re has been the sole source of our share repurchase as well as our equity dividend.

So at this point, during the quarter we did purchase $75 million worth of our stock. AG Re was the sole source of that, and now, as I said in my commentary, we now have access to additional capital in the US operations.

Okay. So were -- was there a portion of the decline that was explained by an increase in reserves ceded to Bermuda?

Primarily it was --

Because those have to be collateralized, right?

That -- most of that was all done -- primarily that was due to the share repurchase and the source of that share repurchase came from AG Re. But as you know, we are scheduled for a contingency reserve recapture at the end of -- in the middle of summer, which would recapture $244 million approximately back to the US, which would free up more assets at AG Re.

Okay, that was my next question which you answered. That's all I have for today. Thank you, guys.

Thanks, Larry.

Our next question is from Sam Palmer from Ascend Capital. Please go ahead.

Yes, actually, it's James Ellman here for -- with Sam. It sounds like you just let out the opportunity for special dividends up from the subs; is that a real option? And if so, could you potentially tell us approximately what sort of size you're thinking about and what the timing might be?

Well, as we look at capital management, available cash to provide the -- basically resources for the capital management, operating dividend, normal dividend capacity, is a principal source. If we decide to enhance that, obviously, we're going to have to seek other sources. I think we talked on our last call, where we think there would be an opportunity for a special dividend is down the road.

We think regulators are still going to be very conservative in looking at the economic recovery, very conservative looking at the stability of our ratings, as well as the continued run-off of the troubled part of our portfolio. So that's a tool, without question, but it's a tool that we don't expect to utilize in the near term.

All right. Thank you very much.

You're welcome.

Our next question is from Darren Marcus from MKM Partners.

Hi, good morning, everyone. I see you guys mentioned debt potentially floating debt for it to be used for repurchases. So I was wondering if there's some -- again, can you give us a ballpark, or is there some debt-to-capital ratio that you guys couldn't exceed or don't want to exceed?

Well, as you know, Darren, the rating agencies do specify debt percentage of the capital. We're well within those guidelines and I'd say anything we would consider would keep us within those guidelines. Remember, one of the principal objectives of the Company is to maintain strong ratings.

Obviously, we don't want to run a foul with any rating agency, especially now that we've got our first upgrade in obviously a number of years. We would hope to see that continue as troubled parts of the credits run off and the RMBS runs down and the structured, that no longer becomes a bad word in the marketplace. So any debt that we would consider, and as I said, it's just another tool to consider to enhance free available cash to try to enhance capital management.

So at this point in time, a consideration -- we evaluate a lot of different components of alternative strategies, of which that is one, that whatever we would do, if we would do it, would still be within every guideline that we would come across. I think the tightest ones would be the rating agencies, but we have a reasonable amount of room there, anyway.

Great. And then one more, if I could. I'm guessing you guys have spent a lot of time thinking about new business opportunities outside of traditional financial guarantee.

So in thinking about your share repurchase program going forward, should I be considering the possibility that you guys would get involved in another business that could consume some of your otherwise free capital, anything like asset management, or specialty financing, or something along those lines? Thanks.

Well, you know, that's a good point but I would say it a different way. It wouldn't really affect excess capital per se. We believe we have significant excess capital. Obviously, we're constrained by some external sources that view our capital maybe differently than we do.

So we try to manage with all those capital constraints, but there's a concept called free capital, but there's always concept called free cash flow. And there's going to be a huge mismatch. So we're going to have excess capital which we would consider not necessary to maintain the ratings, yet we don't have the physical ability to move it out of the Company to use it, for the sake of argument, share repurchasing.

So now you're stuck with a problem saying, well, I've got capital. I need to put it to work or at least get an earning on it. So then you would see potentially some diversification, more on the investment side than the business side.

We like to stick to our core, in terms of what we know. Obviously, we have a restriction in terms of financial guarantors, monolines; it's there for a reason. So as we look at it, we'll continue to look at investment opportunities to utilize capital that although is free or unencumbered, does not represent capital that can be easily transferred out of the Company because of dividend restrictions, regulatory requirements, et cetera.

Thanks a lot.

You're welcome.

Our next question is from Geoffrey Dunn from Dowling & Partners.

Dominic, I was a little surprised to hear you mention, I think it was insurance and the future flow as emerging opportunities in structured finance. I guess I can't really say insurance was -- resonates well with me, from some of the triple X deals we've seen in the past. I was hoping maybe you could give a little more detail on what specific type of opportunities you see in those two areas and why are maybe those the two areas that we're seeing first recover on the structure side?

Well, Geoff, hopefully both of those are risks that we have written historically in the Company going back a number of years. The future flow transactions have been a part of structured finance, and although we've not been active in that market for quite awhile, because the market hasn't requested any of our business, though we're now seeing opportunities.

And you have to understand, the future flow transactions are basically cash flows outside of the country that's lower rated, that provides the opportunity to, in effect, advance those funds. The -- in insurance stuff, which is once again like reinsurance, as you can appreciate it, that is a totally different structure where there is no asset management risk taken by us as the guarantor.

So we believe that lessons we're learning are good lessons learned. We've restructured the way those transactions are now built, and therefore there is no asset management risk. That's obviously part of the (inaudible) and [downtime] issues. So in both cases, business we've done, in one case, we believe business we've significantly enhanced from a risk point of view, and both good returns and good use of capital in the structured finance area.

Okay, that's great on the life insurance. And then on the future flow, that's the same old, like, gas/oil type of deals?

No, it's really around the country, it's diversified payments structure. We usually had a lot of those back in the day, especially in AGC.

Okay. Great. Thank you very much.

You're welcome.

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

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