Ambac Financial Group Inc (AMBC) 2003 Q1 法說會逐字稿

Good morning, my name is Rebecca I will be your conference facilitator today. At this time, I would like to welcome everyone to the Ambac's Financial Groups first quarter conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you.

Tom Gandolfo, you may good your conference.

Great thank you Rebecca.

Welcome to Ambac's first quarter conference call, my name is Tom Gandolfo, I'm the CFO. With me today are Rob Eisman our controller and Pete Pullion, our Director of Investor relations.

As you know, we released earings today at 8:00 a.m. Our earnings press release and statistical supplement are on the web and will be mailed out to those who requested it. If you did not receive it and would like to, please give us a call or visit our website at www.ambac.com. This call will be replayed beginning this afternoon at 2:00 p.m. Please give us a call if you want the telephone number. The call is also being broadcast on the Web. You can access it through the website.

Please mark your calendars, the second quarter of 2003 earnings release will be released on July 17, 8:00 a.m. with a conference call at 11:00 a.m. During this conference call, we may make statements that would be regarded as forward-looking statements. These statements are based on management's current expectations. I refer you to our press release for factors that could changer the actual results.

Let me jump into the highlights for the quarter. Excuse me. It was a very strong quarter for Ambac. Net income up $137.9 million, or $1.27 per diluted share. That's up 19% on a diluted share basis from the first quarter in the prior year. While Ambac reports net income in accordance with GAAP, the research analysts have not adjusted their estimates accordingly.

Therefore, we will continue to provide information on the items that the analysts adjust out of GAAP net income to arrive at their current estimates to eliminate any confusion. Those items are: First, net after-tax gains and losses from sales of investment securities and mark-to-market gains and losses on credit driven contracts which in the first quarter 2003 amounted to net gain of $1.8 million or 2 cents per diluted share. This compares to a net loss of 2.7 million or 3 cents per diluted share in the prior year. We did have a nonrecurring item that is adjusted out. This was a charge-off of deferred expenses related to the issuance of debentures back in 1998 that was recently redeemed. That amounted to $4.2 million. On an after-tax basis, or 4 cents per diluted share. There were no recurring items in the comparable prior period.

Adjusted premiums, excuse me, accelerated premiums undered on guaranteed obligations that have been refunded or simply refundings amounted to $12.2 million on a pre-tax basis or 6 cents per diluted share in the first quarter. That compares to 7.3 million or 4 cents per diluted share in the first quarter of the prior year, that's up 50% on a per-share basis.

I do want to point out we did begin expensing stock options in the first quarter. That was a expense of 1 cent per diluted share and it's not been adjusted out of first quarter '03 amounts as we deem these to be normal recurring operating expenses. But please be aware of this fact when you're looking at your prior year comparisons.

Now, let me jump on to specific line items for the quarter. I'll start with adjusted gross premiums written.

Just to remind folks, that is the gross up-front premiums written plus the present value of installment premiums written during the quarter. We define it as call it AGP. And the current quarter, that came in at 322.4 million, that's compared to 211.9 million in the first quarter of the prior year. That's up 52%. Contributing to the strong performance was significant issuance, strong demand for our product, and a healthy number of large insured transactions closing in the international markets.

Let me take you through some of the detail on the three major areas of our business. Public, structured and international finance. I'll start with public finance.

Ambac's public finance AGP written was 88.3 million -- excuse me, 88.3 million growing 20% from the first quarter of the prior year. Municipal market volume remained robust coming in at 83.9 billion for the quarter, that was up 28% and I believe that was actually a record first quarter. Market penetration was relatively flat period on period but still high at approximately 54%. In the first quarter of '03, public finance experienced strong transactions particularly in the healthcare, student loan, transportation and municipal lease segments.

Moving onto the structured domestic structured finance segment, structured finance AGP grew to -- excuse me, written was 107.5 million, growing 36% from the first quarter of the prior year. This sector includes mortgage back and home equity ABS, other consumer finance transactions, collateralized debt obligations, lease back securitizations, investor owned utilities and asset-backed commercial paper conduties. Increases in this market were driven by strong flow in several areas, including the consumer asset-backed, primarily mortgage backed auto and credit card transactions and commercial asset-backed.

Moving on to international, international AGP increased to 126.6 million, up an impressive 114% from the first quarter in the prior year. This was a very strong quarter for international as we closed several large transactions. We do, however, reiterate our caution as to the lumpiness of this segment. However, deal activity remains solid across several sectors and we continue to view it as a favorable growth market for Ambac.

Let me just take a minute on pricing. Similar to 2002, the competitive pricing environment for our products thus far in 2003 have been favorable and there is no sign of change in the foreseeable future in terms of that changing. Municipal spreads remain wide, relative to the historic trends and we expect them to remain so as state and local budget deficits remain focal points. The investment community continues its flight to quality on the demand for our product is strong.

Moving on to premiums earned, in total, net premiums and other credit enhancement fees earned in the quarter excluding refundings increased to 132.9 million, up 30% from the first quarter in the prior year. This growth was driven by 58% increase in international. Our smallest market, yet highest return market. Public finance grew 16%, very impressive considering it's our most mature business.

Structured finance continues to display strong growth, up 25% during the quarter. Accelerated premiums, which result from refundings, were 12.2 million, or 6 cents per diluted share during the quarter as compared to 7.3 million or 4 cents per diluted share in the first quarter of the prior year. Obviously, municipal refunding activity remains high because of the low interest rate environment. We do expect refunding activity to moderate over time as the number of issues eligible for refunding declines and/or as interest rates go up.

You know, I want to at this time -- I'd like to emphasize our strong cash flow generated from operating activities. Ambac defers premiums received and certain direct underwriting costs and recognizes the premiums and costs over the life of the guaranteed exposure. The net result is the deferral of significant income that will be recognized in future periods. Our cash flow generated from operating activities for the year-ended December 31,2002 was $805 million. For the three months ended March 31, 2003, cash flow generated from operating activities was $177 million.

I point this out really to illustrate, you know, the strong cash flow, I think is a good illustration of the quality, high-quality of our reported earnings stream. Our warehouse of future earnings, which is essentially up front premiums that we've received in cash that we haven't recognized as income yet, or and installment premiums that are contractually due us that haven't been recognized as income yet grew to $3.8 billion. This is up 29% quarter-on-quarter.

Moving on to investment income, investment income came in at 76.6 million, that's up 6% in the quarter. Primarily due to increase in the investment portfolio from ongoing operations. Lower market interest rates on new money invested have impacted the rate of investment earnings growth. Another factor impacting the top-line growth is our continued movement of investments into tax exempt securities. As you know, tax exempts earn lower pretax yield, however, currently generate a higher after tax return for Ambac. Our financial guaranty investment portfolio continues to remain very high quality with 97% of that portfolio rated A or better.

Moving onto the financial services segment, financial services revenues came in at 14.1 million, down 15% from the first quarter of the prior year. Investment agreement net revenue was 3.6 million, that was flat to the prior year first quarter. Investment agreement revenues were impacted adversely by an $800,000 premium amortization adjustment that was due to prepayments on certain mortgage-backed securities in the investment portfolio due to the declining rate environment. Our derivative product revenues came in at 5.5 million, although that was down 22% from the first quarter in the prior year, 5.5 million is still a good quarter there. As we've discussed, that line item tends to be lumpy.

Cash management revenues were down 17% primarily on reduced volume. I would like to highlight a classification change that men of you may have noticed on our year-end financial statements and you will see, probably saw in the first quarter. This is how we report financial services operations on the income statement.

In the past, we reported net intrest income and we now break out gross interest income and expense, we've restated prior amounts for comparebility. This change was made as the presentation is preferred under GAAP however we continue to believe that net interest income remains the more important measure when analyzing this business.

Moving on to expenses, total operating expenses were up 19% quarter-on-quarter reflective of our growing franchise and in line with our revenue growth. I'd like to point out that we did begin expensing stock options this quarter. And that amounted to about $1.5 million during the quarter. So that's in that number.

Moving on to losses and loss adjustment expenses, that line item increased to $9.8 million during the quarter. That was up 4.1 million from the first quarter in the prior year. And it compares to $9 million that we put up in the fourth quarter, 2002. The quarterly run rate in loss provisions has increased from the trend seen in 2001 and the first three-quarters of 2002. This increase reflects both the significant new business generation, as well as the expectation that improvement in the current general market cycle is assumed to be slow and protracted.

This assumption suggests a modestly higher probability of claims from weaker credits, but it also suggests continued strong product demand and above-average credit spreads which overall, we believe, is positive for our business of providing financial peace of mind. In dollar terms, the increase in the loss provision is quite modest relative to the significant new business generation and related earned premiums. By anybody's standard, our loss ratio of 6.8% continues to be quite impressive and we're quite proud of that.

Moving on to ROE, return on equity, we define as -- we exclude net investments and mark-to-market gains and losses and also the unrealized gains that are in our investment portfolio that flow through equity. That ROE came in at a healthy 16.4 percent for the 2nd quarter in a row, so very attractive ROEs. In summary, this was a very strong quarter with excellent top-line AGP of $322 million. 30% growth in normal undered premiums and other credit enhancement fees, and continuing strong demand for the Ambac product at attractive pricing levels.

Before I open it up to the Q&A, I'd like to discuss a couple more items.

First, we did do to debenture in the quarter, which we separately press released and I'm sure most of you have seen. These were highly successful issuances of 100-year debentures. Both have call provisions whereby after five years, if we choose to do so, we can call this debt at par. The first was done in February, was for $200 million and priced at a rate of 5.95%. We seized the opportunity to raise capital at very attractive rates and when this money will be used to fund future growth in our financial guaranty business. The second offering we did was in March. That was for $175 million and we priced it at 5 and 7/8. These funds along with other corporate funds can be used to redeem 200 million of debentures that were issued back in 1998 at a rate of 7.08%. The pricing of both issues this quarter was highly attractive and illustrates the continued demand for Ambac's name in the capital markets. The refinancing of the 1998 debt will result in an annual benefit of more than $2 million on a pretax basis. As I mentioned earlier, we did charge off $6.5 million, $4.2 million after tax of unamortized deferred expenses-related to the 1998 offering.

Finally, just a word on guidance. We did announce in our January conference call that we were comfortable with our long-established long-term target of 15% growth and our underlying earnings which excludes net investment and mark-to-market gains and losses and refundings. Please be reminded that this is a long-term target and we may exceed it or remay miss it quarter-to-quarter improvement, you know, we will no longer be updating our guidance quarterly, though. However, you can assume that our long-term target remains the same until such time as we feel the need to update it.

And at this point, I'd like to open it up to questions.

At this time, I would like to remind everyone if you would like to ask a question, please press star then the Number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster. The first question is from Robert Hottensen of Goldman Sachs.

Yeah, Tom, for the CDO portfolio, maybe you could discuss the current book as it exists today with emphasis on several things; transactions on the watch list, the potential claims to be paid, and then finally, the accounting interplay between mark-to- market paid claims and general loss provisioning.

Sure.

Sure, uhm, our current CDO book which, by the way, is on our website, the details on our website for those who would like to see it, right now, we have about $61 billion of CDO exposure, about 47 billion of that is sinthetic and 14 is in cash market. The quality remains very high. Right now, we have actually 78% of that book is actually natural triple A before we wrap it. 90% is double-A or higher and 97% is investment grade or higher. So it's a pretty high-quality book.

I think as far as credits where we -- any potential claim payments, nothing has really changed since the discussion we had back in the fourth quarter. We still only have one credit that we paid a claim on and that we think we could potentially pay future claims on. That's a credit we paid approximately 4 million already about a year ago, and we think our best estimate now is we could pay an additional, anywhere from five to $15 million on that deal. We have fully reserved for that credit, for a potential offset the high end of the range I just gave you. But that right now is really the only credit that we think we're going to be paying claims on. That deal happens to mature in May of 2005.

As far as the accounting interplay, Bob, that you asked, the sinthetic piece of the book, the $47 billion, is subject to mark-to-market accounting that we do build you know as credit spreads move or as pricing changes in the market, we recognize unrealized gains and unrealized losses on. During the quarter, we recognized $12 million of mark-to-market losses. That was driven primarily by a number of things: We did have one deal that was a triple-A deal that got downgraded to double-A. Still a strong deal lots of subordination, we think it's highly remote we'll pay a claim on it. But just the fact that it was downgraded from triple A to double A, has a mark-to-market impact. That is reflected in this quarter's number.

We also that had a dealed that a credit event in it that eats into subordination and as a result, that makes the deal more sensitive to mark-to-market. So we had that occur in the quarter. Then we also -- one thing I want to point out, I'm sorry to give you such a long answer but it's a topic that everybody seems to be interested in. One thing we do, even if you see spreads narrow generally in the quarter and across the board, we have deals where we would see underlying spread narrowing. However, we don't recognize gains on the deals or reverse previously-booked losses. And the reason for that is because the sinthetic layer that we've wrapped pricing has remained very strong and, in fact, in some cases getting stronger in that even if the underlying spreads narrow unless we know we can trade out of our sinthetic piece at a more favorable price than we executed at, we can't recognize those gains. Because mark-to-market accounting requires you to estimate what the replacement costs of these deals would be and that's what you base your mark-to-market on. So it's not quite as easy as just looking at general market spreads. To get a sense on a deal-by-deal basis.

I hope I answered your question?

Yeah, that was good. You know one quick follow up on the accounting.

Does that mean that if you have a mark-to-market so-called loss, and then you would have a subsequent issue with respect to claims that might be paid, is that loss, you know, used to absorb the claims paid or does that then flow through the loss provision?

Well, it depends on the deal. In some deals it will flow through the loss provision because we may have actually also wrapped the underlying bond. In some cases it will flow through the mark-to-market. In the deals that I've given you whereby we've actually paid a claim, it's actually run through the loss provision on the insurance company. It's at the point we pay the claim. So we've recognized it in mark-to-market before there was a claim being paid and at the point we pay the claim, it gets transferred over to the insurance company. So we do build reserves on a mark-to-market basis, though, on top of that. Right now just to give you that number, we've got about $44 million in reserves built through mark-to-market accounting which is on top of the, you know, the loss -- the $121 million of ACR and 52 million a case we have booked as reserves right now.

Okay, thank you.

Thank you Bob.

Your next question is from Geoffrey Dunn of KBW.

First, can you give us some additional detail on the large transactions in international? I think Rome, part of that, was interested in the other names.

Sure.

Also, would you say that may be you're erring on the side of conservism on your loss ratio provisions in listing the normalized loss ratio higher over the past couple quarters? and finally, can you give it's a bit more detail on the credit event you mentioned on the CDO portfolio? Was that just in one deal or more extensive across your book?

Sure.

Let me just start with the large deals. You're right, we did close some pretty large deals on the international market this quarter. One was the Rome Airport, you're right.

The other deal was the London underground. I think we might have mentioned that was in the works at this time. But that, a large portion of that deal closed in this quarter. And there was also another fairly large transportation deal in the UK. Regarding the loss provision, I hate to ever use the word "conservative" in this environment we're in now. I think it's prudent our loss provisioning.

I just want to point out, you know, in dollar terms, you know, the loss, although the run rate is up, it's still quite modest relative to the new business. We put on $505 million of AGP in the fourth quarter, $322 million this quarter. We recognize the $145 million of earned premium. You know, to keep it in perspective, the 9.8 million is relatively. But I do think it's prudent to accept up the run rate because we are in a challenging economic environment right now. You know loss ratio of 6.8, I do think you're going to see that as a run rate for a while. But that's still a very good number. Regarding the credit event, it was just one deal. It was one name in one deal. So it wasn't pervasive throughout the portfolio. It's the same deal that we've been talking about. This was expected. This was not a surprise. This was within that five to 15 million number we've been throwing out for quite some time how.

It did trigger a paid loss?

It will trigger -- there was actually still subordination in that deal, but that absorbed most credit event but it will probably trigger a loss I'll guess in the three moirtsdz range, a paid loss -- in the $3 million range, a paid loss.

That's coming out of the reserve?

Yes.

The next question is from Caitlin Long of Credit Suisse First Boston.

Good morning, two quick questions. What's the general loss reserve as of March 31? and second to follow up on Bob's question earlier, the jumpup in net unrealized losses on credit derivative and hedged contracts, the two transactions that must you've made reference to as the reason why it went from 3 cents to 7 cents is that right?

Well, not entirely. First the unallocated loss reserve on the -- in the financial guaranty book is 121 million. The reserve we built through mark-to-market accounting is 44 million and then case reserves of 52 million on top of that. The two credits I said on the mark-to-market, that was part of the reason.

The other reason is that when we, you know, if we see even if we see spreads narrowing, we are hesitant, in fact, we do not take down marked -- previously booked mark-to-market losses as long as the market pricing is staying strong. If it's going to cost, you know, if we book a deal at "X" basis points, we know that's what the market is for the sinthetic layer, regardless of what happens to the underlying gain, we won't recognize that gain because we know we can't trade out of the deal for that amount. It's really the three factories that contributed to the 12 million.

So under what circumstance would you actually then reverse some of that?

Two things: One, they reverse naturally over time swu approach maturity of the deal. Just as you roll down the yield curve, the spreads will narrow. And two: If we saw a sustained sustained -- noticeable and sustained reduction in market pricing. What we've seen here over the last six month is we've seen some of our competitors, for whatever reason, slow down a bit in their writings. That's been favorable for pricing, particularly in the market we participate in, the triple-A, super-type A. So as a result of that, we're getting better pricing, but it results in a slightly negative mark-to-market accounting adjustment.

Okay. Thank you.

Thank you.

Your next question comes from Marco of Salomon Smith Barney.

Hi Tom, good morning. Couple questions, what was the mark-to-market reserves that you guys had up in the fourth quarter?

32 million.

Q.32 so increased by 12 million, then?

That's correct.

And just to make sure I understand ow the mark-to-market works, I understand what you're sale about the pricing. Shy assume that at maturity you've got a complete reversal regardless of what pricing's doing? Let's assume pricing actually continues to increase from here?

Absolutely. At maturity, once the exposure is gone, you would reverse all the previously booked reserves. In reality, Marco, what will happen is generally when you get down to probably the last 12 months of deal, you'll start -- it won't really wait until maturity, but when a deal gets close to maturity, within a year, let's say, you'll start seeing -- assuming there's not a credit event, you would see a dramatic reversal of any previously loss booked reserves at that point.

Okay. All right. And then another question is: Premium retention was the lowest since the third quarter of '01. Should we assume that was just an aberration this quarter or --

Yeah. You should. That would not be the run rate. That was really the mix of business during the quarter up front versus installment and there was, you know, a fair amount of healthcare deals that we did. So I would say it's a bit of an aberration and the run rate would be more in the 10 to 14% you're used to seeing.

Finally, you might have answered this one before: Was financial services tax rate was way down. Was that just a shift in investments? What's going on there?

Actually, good point. There was a shift in investments. We were able to, as I said we did if the financial guaranty portfolio, to some extent we're doing the same in the financial services portfolio. We had a sizable pickup in tax exempt income in that segment.

Great, thank you.

Your next question comes from Bill (indiscernible) of Morgan Stanley.

Hi, good morning. Following on the last question about the reinsurance, could you talk about the changing dynamics in the facial guaranty reinsurance sector, how it's affecting your business and I guess to the extent you can comment on your views of using more traditional reinsurers in your reinsurance portfolio, that would be helpful.

Sure, a lot of press lately on the reinsurance.

You know last quarter we talked you know S&P had down a number of downgrades from triple-A to double-A, I think we saw actual last quarter decide to depart the business and more recently, we've even Emery come out with a similar announcement. The world is getting smaller there. I guess a couple points. Not a huge impact on Ambac because I think we're not huge userss of reinsurance. I think we're the smallest user of reinsurance in the industry. You still do get 70% credit in the rating agency capital models or double-A reinsurers. So, you know, we've looked at this carefully. We don't think -- well, we know it's thought going to have a material impact on Ambac. There's actually some positives, you know, the positive being less capacity in the market, from particularly for the heavy users of reinsurance. We think that's going to be a positive for pricing.

And just one other thing, when we talk about using, you know, nontraditional sources, one of the things we think will be quite attractive, particularly on the large complex deals, will be the using, you know, reinsuring with other triple-A model lines. We like that to some extent because obviously, you know, the claims, we have a lot of confidence in their claims paying ability and financial strength. And also we think that that could generate kind of a back and forth flow of business where we show them a deal, they show us a deal. Some deals we may not have had an opportunity to work with, we mate get that opportunity. That's another strategy that we're considering.

That's helpful, thanks. I guess that leads into another related question. You mentioned the S&P capital, could you just remind us the, I guess, two things: The level of excess capital, I think it's only S&P's model that lends itself to quantifying excess capital relative to the triple-A standard. But so there's that, the level and just during the course of 2003, the points in time at which you'll be interacting with them in getting feedback on how that, you know, has changed, you know, with back to evaluation data of year-end '02, for example?

Sure. Sure. Couple things.

We actually what we do is as of December 31, we run the model and then we ship it over to S&P and they review it and edit it and basically audit it. And we just completed that process. That was all due over to them at the end of March and we did it and send it over. Of course we look at it internally on a constant and ongoing basis but we do a full-blown audit once a year. We just completed that, we do know where our excess capital is. I hesitate, I don't like to throw a number out, I don't think it's fair to S&P, I'd rather wait this will they completed their work, I believe they publish it.

What I can tell you is there's significant cushion, very comfortable, which is kind of always our style. We like to maintain that cushion so no certains. You'll see a number you're comfortable with, I'd rather you heard it from S&P. As far as feedback, you know, we meet with the rating agencies constantly. In fact, S&P I think was in here yesterday meeting with some folks. So we should hear the feedback on the model very shortly but I don't anticipate -- it's pretty mechanical calculation. So I don't anticipate any surprises there.

Okay, very good. Thank you.

Thanks, Bill.

Your next question comes from Terry Shu of JP Morgan.

Hi, Tom, I notice that you didn't update your earnings forecast whereas prior you gave a fairly precise range. I gather that's intentional, that you can't really pinpoint earnings, as you say. However, just looking at the underlying trend it's quite powerful all you have to really look at is premiums earned growth, which is accelerated and the amount of business you're putting on, you can't help but see continued strong premiums earn growth if you said your warehouse of earnings. For this last couple of quarters, you had the dampening impact of invest in income comparisons, but that's going to moderate. And perversely this mark-to-market negative adjustment, because of strong pricing, as you said, will flow in to the bottom line as the deals mature.

So one should, just with the trends in place, and acceleration of earnings comparison perhaps a bit over your longer term trend line, although the longer term trend line I understand is what your target is. Is that a fair way of looking at it?

Well, I mean, we're really hesitate infant, not just Ambac, I think we're jumping on the band wagon with every company that just thinks putting out quarterly estimates isn't a good idea.

I don't think it's a good idea, I'm just saying that the momentum or dynamic is such that the growth has already occurred, a lot of it and the moment doesn't seem to be stopping and the premiums earn growth you can extrapolate will, by definition, be quite strong.

Yes, I think it's fair to say you clearly see an acceleration in the earned premium line. One of the most important lines on the income statement. A 30% growth rate is quite impressive, although it shouldn't be too much of a surprise, if you look at the writings, it only makes sense. It's now flowing through to the earnings line.

So again, my general comments, or observations you would agree with that --

the trends are positive. The trends are quite positive, I mean, you have all this underlying momentum. Yes.

And on pricing, I think I heard you at the beginning of the call that it's very strong across the board. As you said, you don't see any changes in that. Are there any pockets of weakness or new competitive threats or really everything looks pretty good?

Yeah, the right now, the only place that I would say -- it's strong almost across the board. The only place where we've seen some tightening of spreads, and this is reflected in the fact that we didn't do a whole lot of business this quarter in this area is in the investor-owned utility area.

What's happening there is -- that's an area we've been quite comfortable with or a long time, an area where maybe the market hasn't been quite as comfortable if you recall back to previous calls, we got lot of investor questions, a lot of concern. But the investment community now is seeing the opportunities we saw long ago and investor demand for IOU paper is quite strong. As a result, we've seen spreads narrow. That's probably the only area that I can think of where we've seen noticeable spread narrowing. But the other across the board in municipal, international, structured pricing is still quite attractive.

Thank you.

Thanks, Terry.

You have a follow-up question from Jim Dunn of KBW.

Tom, given the move in the municipal investment portfolio, can you give us a little bit more guidance on where you expect the corporate tax rate to trend over the year?

I think, Jeff, you're probably going to see it hover right around where it is. Although we're moving money into tax-exempts and it's mitigating tax exposure, the good problem is on the other end, the taxable piece of the business, the earned premium and other types of income is accelerating. You got a bit of counter balancing going on there. You got the earned premium taxed at the 35% rate, the growth and the tax exempt taxed at a lower rate, they pretty much balance out. I think, you know, if you use the rate you're seeing, the 24%, probably give you a pretty good estimate.

Okay. And then can you provide an update on the two extra credit deals that we have reserves up against? Have there been additional payments and have you completed your review of the MBS book to determine what went wrong there?

Sure. Yeah, these are the two deals we talked about last quarter. We mentioned I think last quarter, it's really one deal that we've paid claims on. But there's another deal that we're keeping our eye on because we think we could potentially pay claims on that as well. We did pay $3.3 million in claims this quarter. We've done, you know, we constantly look at the mortgage book. We know how every single deal in that book is performing.

I can confirm that these two deals are clear outliers. We are aggressively completing a review of these deals. We're auditing them, you know, still evaluating, we're not done with that review. But we think that -- and I don't want to make any promises here -- but we do think there will be some recoveries from these claim payments. But no guaranties. They were clear documentation short comings and initial poor servicing that we think will result in recoveries. But we'll have to see how it plays out. It takes some time to work out, we're reviewing every single loan, and as you can man, numerous loans.

Okay, thank you.

The rest of the book is performing very well.

All right.

And you have follow-up question from Marco Pinzon of Salomon Smith Barney.

a couple of follow ups here on the mark-to-market reserves of $44 million. Since 15 relates to that one deal, how many deals are actually being addressed here?

That's the entire book, Marco, the entire book.

That's -- I'm sorry?

That's our entire, when you say how many deals, that's the entire -- that's the reserve on our -- all our sinthetic CDOs.

Right, I understand that, but how many different, I don't know, credit default swaps are being addressed by that reserve?

How many transactions?

Yeah.

Oh, geez. Off the top of my head, I don't know I'll have to get back to you on that, how many there are. I mean, it's the 45 billion notional, I'm not sure how many deals it represents. I will say the super senior deals, the super AAAs tend to be very large --

I guess what I'm asking, are there any specific transactions or you're covering the entire book?

Oh, no, that's the entire book. It just so happens when you build up that 44 million, you do it on a deal-by-deal basis and it happens, you know, a big chunk of the reserve happens to relate to that one transaction that we've talked about.

Okay. And then what other reserves that you have up right now on the extra credit deals?

Actually we haven't disclosed that, the reason for the purpose that, Marco, I can tell you we fully reserve what had we think our ultimate loss is going to be. The reason I hesitate throwing a number out, we are in aggressive negotiations with the originator there. In trying to seek recovery. So at this time, I really don't think we should be throwing that number out. Okay. Okay thank you, Tom.

Okay, thanks.

You have a follow-up question from Robert Hottensen of Goldman Sachs.

Hi.

Tom, my general question is related to the environment for refundings in the public finance market. It seems to me the usual pattern is that refundings create a benefit in terms of the accelerated premiums that you get, you know, when you refund in a lower rate environment. Maybe you could address the IRRs on new business and you are whether -- and whether, you know, what kind of step-up, if any, you're getting in premium rates, and the overall capacity to increase credit quality through restrictive covenants and other triggers and so forth in that marketplace?

Sure.

Are you talking about general market or --

I was really referring more to the public finance market. And the real question is: You put your arms around some percentage of refundings that, you know, really create few not only the classical acceleration of premium income, but where you actually have benefits in terms of your own IRRs or.

Yeah.

-- or, you know, the ability to put on more restrictive covenants and so forth.

Sure.

In terms of the refunding levels, that's so difficult to predict in terms -- you know, it's all interest rate driven, primarily. But what's happened in the environment that we're seeing in the U.S. municipal sector, you know, issuance is very strong still as a result of two things: One, this low interest rate environment, and two, you know, the budget deficits. You know we're particularly happy in the municipal sector with what we've been developing, that's the structured side of that business. We're seeing good opportunities there and the pipeline is very strong. And that, Bob, might be what you're referring to in terms of where we're seeing good structuring opportunities and we're seeing that, we're seeing it in the structured side of the business as well.

The more concerns folks have with the economic cycle, quite honestly the better for our business and that means the better in terms of pricing, in terms of IRR. But importantly, in terms of structure, we've always been very diligent on our structuring, but in this environment you do have a bit more leverage. So, you know, in terms of IRR in an environment when pricing is strong and attractive almost across the board, that's obviously favorable for the IRRs.

And are you seeing incremental demand, you know, in that market not necessarily motivated by lower rate, which typically is the big motivation on the refunding, but either the need for more new money or other expansion in the original facilities?

It's -- to some extent your seeing it in two areas, unrelated to interest rates. The budget deficits in one area that's increased the demand. An $84 billion issuance in the first quarter in the U.S. public finances is quite significant, a record for a first quarter. But where we're also seeing good flow is something we talked about earlier is the, you know, governments are starting to more and more, you know, push down the funding to the local level. And, you know, that's creating some interesting opportunities in terms of flow as well. I'm not sure, I did answer your question?

That's great. Thank you.

Okay.

At this time, you have no further questions.

Okay.

One final time? Great. Anything else? Any other questions?

No, sir.

Okay. Well, thank you all very much and Rob Eisman, Pete Poillon and myself are here all day, please feel free to call any one of us with follow-up questions. And thank you very much.

This concludes today's conference call, you may now disconnect.