Assured Guaranty Ltd (AGO) 2015 Q3 法說會逐字稿

Good day, and welcome to the Assured Guaranty Limited third-quarter 2015 earnings conference call and webcast.

(Operator Instructions)

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

Thank you, operator, and thank you all for joining Assured Guaranty for our 2015 third-quarter 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, 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're listening to a replay of this call, or if you're reading a transcript of the call, please note that our statements made today may have been updated since this call. Please refer to the investor information section of our website for our recent presentations, SEC filings, most current financial filings, and for the risk factors.

And 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'll open the call to your questions. As the Webcast is not enabled for Q&A, please dial into the call if you would like to ask a question. I will now turn the call over to Dominic.

Thank you, Robert, and welcome to everyone joining today's call. The third quarter of 2015 was another successful quarter for Assured Guaranty. We produced $164 million of operating income and continued to build the Company's financial strength, market position, and value to our shareholders. Our year-to-date operating income of $582 million is 42% higher than the first nine months of last year. At September 30, operating shareholders' equity per share stood at a record $41.87 per share, and our record adjusted book value per share was just shy of $60.

As Rob will detail in a few minutes, we continued to optimize our capital usage during the quarter. Additionally, we continued to generate excess capital as our insured transactions amortized and we further derisked the portfolio with rep and warranty settlements, loss mitigation bond purchases and targeted terminations. That said, the fundamental demand for our core product, municipal bond insurance, is increasing, even in this environment of low yields and tight credit spreads. This is clear when you look at our industry's 51% growth in new insured pars sold in the first nine months of the year, compared with a 40% growth in total new issuance.

Insured penetration of the municipal bond market has generally fluctuated this year, in line with interest rates. It grew to 7.5% in the second quarter, and fell back to 6.1% in the third quarter, as municipal bond yields dropped 30 basis points after an 85 basis point rise from their low point in January. Year-to-date penetration through September 30 was 6.5%, up from 6% in the first nine months of 2014, and that is a real achievement since the 30-year benchmark municipal yields averaged 45 basis points below the average for the nine months of 2014. As we look at the new issues sold with A underlying ratings, municipal bond insurers captured 17.9% of the pars sold in the third quarter, and 21.4% of the pars sold year-to-date. In both the third quarter and year-to-date, more than half of the underlying A transactions were insured.

Assured Guaranty continues to lead the municipal bond insurance industry. We believe issuers, broker-dealers and investors recognize superior value, and our financial strength, including our $12.4 billion of claim-paying resources, and our proven profitable business model, and our insured bonds' exceptional market liquidity, with an average daily trading volume of more than 500 million during 2015.

In the third quarter, we guaranteed $3.1 billion of new municipal issues sold, representing 60% of the insured par and 56% of the insured issues during the quarter. We guaranteed 43 more transactions than the rest of the entire industry combined, and in the month of August alone, we guaranteed 72% of the insured new issue par. Additionally, we increased our secondary market par insurance by 38%, compared with the third quarter of 2014.

The credit quality of the municipal bonds we insured this year is better than last year, which helped explain why the PVP in last year's first three quarters exceeded this year's results. While lower overall yields and tighter credit spreads also contributed to the reduced PVP generation, last year's Detroit Water and Sewer restructuring transaction was the most important factor contributing to the higher PVP in 2014.

In looking at credit quality, it's worth noting that year-to-date through September 30, we insured 48 transactions with AA underlying ratings, including 12 in the third quarter. In comparison, during the first three quarters of 2014, we insured only 19 of such deals. The lower premium rate on AA transactions still represents a good return, because of the lower rating agency capital charges.

We also led the market because we provide superior service through a broad range of transactions. In the third quarter, we insured 176 issues with par amounts of $25 million or less, while also insuring seven transactions where par exceeded $90 million. Pricing during the third quarter saw nice improvement, relative to the first six months of 2015.

Now let me bring you up-to-date on Puerto Rico developments. The municipal revenue collection center, known as CRIM by its Spanish acronym, and the Government Development Bank have come to an agreement that creates a trust for certain local property tax revenues that CRIM had refused to deposit with the GDB, because of worries about the GDB's liquidity position and the appropriate segregation and investment of these deposits. These funds are pledged as security for the Puerto Rico municipal finance agency bonds, most of which are insured by Assured Guaranty. We are paying close attention to this matter, and will take whatever action is necessary to ensure that the timely application of the pledged revenues to the payment of the MFA bonds.

Turning to the Puerto Rico Electric Power Authority, or PREPA, in mid-September, we declined to grant a further extension of our forbearance agreement, in order to underscore the urgency of negotiations, and to reserve all available options to protect our contractual rights. However, we continue to work with PREPA to reach a consensual settlement that is designed to put the utility on a sound financial footing going forward. If enabling legislation is passed by the Puerto Rico legislature, this potential agreement should result in modernization, long-term sustainable rates to customers, and continued access to efficient financing.

The Treasury and some Puerto Rico officials advocate a retroactive change in the law, that if enacted, would allow an unprecedented bankruptcy regime that has been called Super Chapter 9, an even worse idea for Puerto Rico and its residents than earlier proposals, because we believe it would ultimately impair the Commonwealth's economic prospects. As proposed, it would give the territory broader powers to impair long-term obligations than those afforded to any US state. If enacted for Puerto Rico, Super Chapter 9, or for that matter, approving use of the current Chapter 9 in Puerto Rico, would reward fiscal and operational mismanagement, and harm bond holders and Puerto Rico residents alike by ignoring the real issues, especially how to jump start economic growth and foreclosing the island's future access to efficient financing.

At the same time, it would penalize those long-term investors in Puerto Rico, many of whom are citizens of the Commonwealth, who supported Puerto Rico with the express understanding that bankruptcy was not available, and Puerto Rico would honor its constitutional and contractual obligations. There is no justification for initiatives that would retroactively undermine the Puerto Rican constitution and the legal rights and remedies that were the basis on which bondholders agreed to provide financing for the island's development.

We welcome the construction involvement of federal authorities, if it helps address the root causes of Puerto Rico's crisis. Incentivizing economic growth, facilitating access to efficient financing, and providing federal oversight of fiscal management, would not only provide near-term financial relief but also long-term economic sustainability. For example, modifications to provisions applicable to federal healthcare reimbursement, or oversight mechanisms like those used in the 1990s to assist the District of Columbia could contribute to a solution, but any federal initiatives should aim to restore and enhance Puerto Rico's capital market access, not impair it.

Federal and local officials should focus on solving the very serious structural problems that have been neglected for far too long: mismanagement, inefficiency, tolerance of tax evasion, and lack of transparency. On this last point, Governor Padilla asserted in a recent Congressional testimony that the Puerto Rican government had a history in his words to hide information to the market, so they were able to have more access to the market.

Such unconscionable behavior goes hand in hand with the widespread corruption described in a report of the Puerto Rico Civil Rights Commission released in July. This report enumerates many problems that are both serious and widespread. For example, almost half the money collected by merchants for the sales and use tax is not remitted to the Department of Treasury of Puerto Rico. Additionally, more than 200,000 water customers do not pay for it. This is obviously one reason that the Puerto Rico Aqueduct and Sewer Authority estimated in its August 2015 preliminary official statement that almost 60% of the water it produces provides no revenue.

The Commonwealth government can not wash its hands of this history by blaming it on prior administrations, because the problems still exist today. Now, it claims the only viable solution is for the US Congress to permit a wholesale abrogation of contracts, many of which are constitutionally protected. It would be bad public policy for Congress to approve a bankruptcy regime that permits the Commonwealth and its instrumentalities to impair debt that was sold to investors based on possibly misleading or incomplete disclosure practices, as the governor claims.

Such Congressional action would condone inadequate disclosure, and run counter to the SEC's efforts to promote better disclosure practices in the municipal bond market. It [would affect] not only the market for Puerto Rico debt but the entire municipal bond market. Investors would no longer be able to trust constitutionally-protected promises to pay debt, and the cost of borrowing for states would almost certainly increase, because it would no longer be certain that they could cannot declare bankruptcy. Some states might demand the same rights to impair obligations that are proposed for Puerto Rico, further harming the other states that have taken responsible steps to manage their fiscal affairs.

There is a better way. Fair and equitable negotiated agreements with creditors are the best solutions, because it is in everyone's interest to see Puerto Rico correct its operational shortcomings and build a robust economy based on real strengths, which is only possible if capital market investors resume funding essential infrastructure at a cost Puerto Rico can afford. We have been a long-term partner of Puerto Rico and its people, helping to lower the cost of financing its roads, schools, utilities and other infrastructure for decades. As long as our rights are respected, and the government shows the political will to correct the long-standing deficiencies, we look forward to playing a constructive role in Puerto Rico's efforts to restructure its debt and improve its economy.

While I look ahead to the fourth quarter and next year, I see important opportunities. In our international business, in addition to the new infrastructure transactions we may have the opportunity to replace, other legacy financial guarantors on existing insured transactions. On the structured finance side, the Basel III and Solvency II capital regimes are creating opportunities for us in the banking and life insurance sectors respectively, where we provide tools for managing capital more efficiently.

The global ABS market like the US public finance market should offer more opportunities once yields rise and credit spreads widen. This week, Federal Chair Reserve Yellen said that an increase in the benchmark interest rate at the Fed's December meeting is a live possibility. Whether or not it occurs that soon, an improving economy and labor market will almost certainly lead to an increase from the zero rate in the near term, which would likely result in higher interest costs for borrowers. As we've seen in the past, higher interest rates should increase demand for bond insurance.

I'm confident about the future and we will continue to look for prudent and creative ways to expand our market and create value for our policyholders and shareholders. I will now turn the call over to Rob.

Thank you, Dominic, and good morning to everyone on the call. Today I would like to start with a discussion of operating income. For the third quarter of 2015, operating income was $164 million, or $1.12 per share. That compares with $177 million or $1.05 per share in the third quarter of 2014. This quarter's operating income reflects the continued success of our loss mitigation efforts, the contribution to earnings from the rating portfolio, and premium accelerations due to negotiated terminations of non-RMBS transactions. It also puts includes higher US public financed loss reserves reflecting recent developments in Puerto Rico, which Dominic just described.

Net earned premiums and credit derivative revenues were $252 million in the third quarter of 2015, compared with $166 million in the third quarter of 2014. This increase relates primarily to higher accelerations which were $105 million in the third quarter of 2015, including $18 million from the rating asset portfolio. This compares with $36 million of accelerations in the third quarter of 2014. Net earned premiums and credit derivative revenues were further bolstered by the contribution from the rating asset portfolio we acquired in April 2015. Net investment income in the third quarter of 2015 was higher than the third quarter of 2014 by $12 million. The increase was a direct result of a number of the Company's strategic initiatives, including income on loss mitigation securities, alternative investments, and the contribution from the rating asset acquisition.

Total economic loss development was relatively flat for the third quarter of 2015. The economic benefit in the US RMBS and other structured finance sectors was a total of $94 million. For the public finance sector, we had $91 million in economic loss development, mostly related to Puerto Rico exposures. The US RMBS economic benefit of $76 million was primarily a result of several of our loss mitigation strategies, including one R&W settlement.

Moreover, we successfully terminated several US RMBS transactions, resulting in a decline in below investment grade net par outstanding of $921 million. The economic benefit relating to the other structured finance sector was $18 million, and driven primarily by one CMBS transaction that was acquired as part of the rating and asset portfolio and subsequently terminated. This reduced below investment grade net par outstanding by an additional $430 million. The impact of changes in the risk rate discount rates was a loss of $11 million across all sectors.

With respect to our capital management strategy, in the third quarter of 2015, we purchased 5.4 million common shares for a total of $135 million at an average price of $25.17 per share. From the close of the third quarter of 2015 through November 5, we purchased an additional 1.7 million shares, and now have $143 million remaining under our share repurchase authorization. Since the beginning of 2013, we have repurchased a total of 54.6 million shares for $1.3 billion, at an average price per share of $24.19, representing 28% of our total shares outstanding at the beginning of the repurchase program in 2013.

The impact of share repurchases on the third-quarter 2015 operating income per share was an increase of $0.24. Operating shareholders' equity and adjusted book value per share increased to record highs of $41.87 per share, and $59.97 per share, respectively. As of October 31, we had approximately $55 million in cash and investments at the Bermuda holding Company, and approximately $74 million at the US holding companies. I'll now turn the call over to the operator to give you the instructions for the Q&A period. Thank you.

(Operator Instructions)

The first question comes from Bose George of KBW. Please go ahead.

Let me just start with, you mentioned the investment income increase. Is that a good run rate going forward? Also, same for the operating expense number, which came in better than we thought.

The investment income number was elevated, Bose, due to redemption we had on an alternative investment that we put in the CAT space, in the CAT ILS space. In addition to which, it was further benefited by an increased yield on the PREPA bond that we received as part of our purchase on July 1. So that bond has a significant yield. So I would say that the investment income number was a bit elevated due to that. And with respect to expenses, last quarter was elevated because we had the rating acquisition expenses. This quarter, I would say is more indicative of what expenses should be, and I would expect that to be consistent going forward.

Okay. Great. Thanks.

And then just one on Puerto Rico. Do you have any upcoming debt payments before January 1, aside from the GDP payment, and do you think January 1 becomes the new fallback date by which something needs to get resolved, or could this go even further than that?

On the debt service payments, Bose, we don't have that much due. I think you're correct in looking at January 1 as being the real fallback date for PREPA. Obviously there's some other payment, the government's responsible for, most importantly the GDB, of which we have very, very little, so it's not significant on our books. For us, it's really January 1, but if you look at the schedule that we provide in the financial supplement, our debt service relative to most of Puerto Rico exposures over the next five years is not insignificant, but pretty benign relative to overall exposure.

And then just in terms of something being resolved by January 1, do you think the chances are reasonably good, or do you think this could get pushed out as well?

I think there's been a lot of press coverage of this and a lot of statements made publicly by a lot of constituents, but there's a firm belief, and we're also in that camp, that there is a deal out there to be done. Obviously, the devil is always in the details, and there's a lot of legislative activity that needs to be accomplished to make all the components of the deal work. But we are, at this point in time, still working hard to get a consensual agreement, which we believe is achievable.

Okay. Great. Thank you.

The next question comes from Sean Dargan of Macquarie. Please go ahead.

Thanks and good morning.

Given where you are in Puerto Rico, and there's no restructuring announced, I think a lot of investors probably think there's a low probability of getting permission for extraordinary dividends out of AGC and AGM. I'm wondering if you could maybe help us think about what the ordinary dividend capacity in 2016 will look like? Some of the puts and takes with stat net income, net investment income, et cetera.

Hey, Sean, it's Rob.

I would point you to page 8 of the equity presentation, because I think that clearly shows what we think our dividend limitations are, our operating subsidiaries. When you look at that page, the dividend limitation out of AGM annually is around $216 million. At AGC, it's about $89 million, and at AGre it's $271 million.

If you add all of that up, it's $576 million. You take out the expenses you need at the holding Company, it's about $190 million something, you get net about somewhere in the mid-$3 million. Obviously, we like to keep a cushion. So we've said in the past that at the end, I would argue that it's somewhere in the mid-$2 million that would be available for share repurchase. So I think, based on these numbers, that's what I think you should look at.

Okay. And so mid-$2 millions for full-year 2016 would indicate a stepdown from what you've done this year. Is there anything else you can see on the horizon that might add to your share repurchase capacity?

We can always look at further extension or the increase to debt as one of the tools that we would typically use. Obviously, depending on how the Puerto Rico schedule goes, if we get our PREPA deal done, I think that takes a lot of marbles off the table. If there's further clarity around the other risks that are out there, which we have views on, of course, I think 2016 doesn't for me preclude the potential for a request for some additional dividend capacity. But I think, as we have said many, many, many times it's still going to rest on Puerto Rico, but a PREPA deal announced somewhere in this year would be a good first step, and then as we address the other exposures in 2016, I'm not willing to give up on 2016 as a potential year for further activity.

Okay. Just following up on Bose's question.

There's an awful lot of news flow out of Puerto Rico, and it's hard to tell what's important to you, and what's not. Would a restructuring of PREPA be the most immediate concern that shareholders should be concerned about?

Absolutely. Obviously, with the debt service schedule we've got, as I said that's probably the most material thing we've got coming up January 1. And yet you think about it in the bigger context, PREPA has always been described as the most troubled credit. It was the one that really facilitated a lot of the talk about ability to pay and restructuring.

So getting that off the table, I think is a huge positive step, and would potentially put some confidence back in the market, that things can be worked out on a rational basis without government interference, meaning Federal Government interference, and let the markets respond to the challenges that they have, and use the tools that are available to them through the contracts, et cetera, to get things done.

Thank you.

(Operator Instructions)

The next question comes from Brian Meredith of UBS. Please go ahead.

Couple things. Rob, just quickly, can you give us the specific, the redemption of alternative, what was the actual dollar figure, just so we can adjust my go-forward investment income numbers?

I believe it was around $4 million.

$4 million. Great. Thanks.

And second question, what was the driver behind the increase in the reserves for Puerto Rico this quarter?

Okay. We finally got to the question of the day, and Rob can give you a lot more detail. Remember, in GAAP, we've got to go through a scenario analysis of probability weighting. As we look at everything that's happened, taking all available information, so on one side of the ledger you look at available information in the third quarter and through to basically today, we have a potential PREPA restructuring deal. That's fact one.

Fact two, we've got potential federal involvement including the possibility, although we don't give it a high probability, of some super bankruptcy bill. Step three, to the extent that the Commonwealth feels that it can't pay its obligations, that invokes the potential, and we do say the potential in small caps here, of a clawback. Clawback for us affects primarily our transportation exposure, which of course you can read on our schedules is the largest exposure that we have within the Assured Group as it respects Puerto Rico debt.

However, we would say if you really look at the technicalities of the clawback, it's something very, very, very difficult to achieve, and we think there's a lot of both remedies and defense against that. But be that as it may, as we look at GAAP reserving, all those things have to be scenarioed and therefore probability-weighted, and therein lies how we come up to our reserves.

So our reserves is really what we have to book relative to what the rules are around accounting. It might contra or contradict our own specific views or guesstimates of what we think ultimately happens, but this is not a manuscript. This is something that has to be done, based on a formulaic approach.

Those three main factors are the things that would have contributed to the reserve movement in the quarter, two of them which are negative, one being federal involvement, two being potential clawback. Although we would put the probabilities of those very low, put a probability on any loss estimate from those factors happening, and ergo you get reserves.

Does that help?

That's very helpful. And just a quick follow-up. Given what you just said, would that mean that under the current PREPA deal, you're adequately reserved?

We are reserved. Will Rob say it's adequate? [multiple speakers]

I mean, what you have.

We'll wish him well. We'll visit him on Sundays, but that would be not a very good outcome.

I believe you signed the financials, as well.

It's always the CFO that goes to jail.

Great. Thanks.

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 us a call. Thank you very much.

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