Ambac Financial Group Inc (AMBC) 2003 Q4 法說會逐字稿

It is now my pleasure to introduce your host, Mr. Thomas Gandolfo, CFO of Ambac Financial Group Incorporated. Thank you Mr. Gandolfo. You may begin.

Thank you very much, good morning. Welcome to Ambac's Q4 Conference Call. My name is Tom Gandolfo, and with me today are Rob Eisman, our Controller, and Peter Poillon, Head of Investor Relations.

Our earnings press release and quarterly supplement are on our website, and will be mailed to those who have requested it. The call is also being broadcast on the web, and will be accessible through March 31. You can access it through our website, at www.ambac.com.

Please mark your calendars. Q1 2004 earnings will be released on April 21 2004, at 8 a.m., with a conference call scheduled for 11 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 change actual results.

Let me just give you the highlights for Q4. It was another strong quarter for Ambac, net income was $158.8m, or $1.44 per diluted share. That's up 144% on a diluted share basis, from Q4 '02.

As you may recall, Q4 '02 net income was impacted by a $91m after-tax write-down of an investment security in our financial services investment portfolio.

While Ambac reports net income in accordance with generally accepted accounting principles, research analysts do not adjust their reported estimates accordingly. Therefore, we continue to provide information on the items that analysts adjust out of generally accepted accounting principles, or GAAP net income, to arrive at their current estimates, to eliminate any confusion.

Those items are net after-tax gains and losses from sales of investment securities, and mark-to-market gains and losses on credit derivative contracts, which in Q4 '03 were net gains of $4.7m, or $0.04 per share. This compares to a net loss of $72.4m, or $0.66 per share impact in Q4 '02.

Additionally, we incurred a non-recurring after-tax charge of $8.4m, or $0.08 per share, from the previously announced sale of our discontinued operations of our Cadre entity, which is our small investment advisory and cash management business.

The other item that's adjusted out is after-tax accelerated premiums earned, on obligations that have been refunded. That amounted to $16m, or $0.15 per diluted share in Q4. This compares to $10.2m, or $0.09 per diluted share, in Q4 '02. It was up 67% on a per-share basis.

An important statistic is cash flow from operations, cash flow that we generate from our ongoing operating activities. For the first time ever, this exceeded $1b for the year. This illustrates our continued ability to generate significant liquidity internally.

Moving on to production, adjusted gross premiums written, this was our third best quarter ever for premium production, as AGP came in at $429m. That is down 15% from the all-time record, of $505m, in Q4 '02.

AGP this quarter was over 2.3 times the rate of our premiums earned, and other credit enhancement fees. AGP for the year was $1,489m, that's up 15% from the prior year.

Let me just take you through some of the detail on the three major areas of business.

First, there's public finance. Public finance AGP came in at $198m, that's down 9% from the lofty Q4 '02. Municipal market issuance was strong, achieving a record $380b for the year. Issuance came in at $93b for Q4, only slightly down from an exceptional Q4 '02. Market penetration trailed off somewhat, coming in at 40%, compared to 45% in the comparable period of 2002.

Moving on to structured finance domestic. AGP written came in at $108m, that was down 38% from Q4 '02. Q4 '02 was a record, of $175m. This sector includes mortgage-backed and home equity asset-backed, other consumer finance transactions, commercial asset-backed, collateralized debt obligations, investor-owned utilities, and asset-backed commercial paper conduits.

The decrease in AGP during the quarter in this market was primarily due to the fact that the prior year included a very large commercial asset-backed transaction. Also contributing to the decrease was less activity in the insured mortgage-backed securities market.

Although mortgage-backed security volume remains robust, the senior substructure was strong competition during the quarter.

Looking forward for the mortgage-backed sector, it appears that volumes will still be healthy, as interest rates remain low. No one can predict if competition from the senior sub mortgage-backed market will continue at current levels, since the ebbs and flows of investment sentiment can create significant demand shifts quarter-to-quarter.

Volume is healthy in commercial asset-backed securities and investor-owned utilities.

Moving on to international finance, international AGP was impressive in Q4, coming in at $122m. That's up 8% from Q4 '02. The quarter's results were primarily dominated by a few large structured finance transactions, which included asset-backed and transportation deals.

International markets in general remain quite robust, providing ample opportunities with attractive returns. However, as we have repeatedly stated, quarter-on-quarter volume in the international market will be lumpy, as the slow business represents a small fraction of premiums written in that market.

Moving on to premiums earned, net premiums and other credit enhancement fees earned, excluding refundings, increased to $158m. That's up a solid 29% from Q4 '02. This growth was led by a 40% increase in international.

Structured finance domestic continued to show a growth pattern, up an impressive 31%. Public finance, our most mature product, continues to grow, as strong issuance and our focus on transactions where our guarantee brings the most value drove an increase of 18%.

Accelerated premiums from refundings were $28m, which is $0.15 per diluted share in the quarter, as compared to $18m, or $0.09 per diluted share, in Q4 '02.

Interest rates remain low, relative to historical levels, and refinance remains attractive to those who are eligible. We do expect refunding activity to slow over time, as the number of issues eligible for refunding declines, and/or as interest rates increase.

Deferred earnings, representing future earnings that are in-hand or contractually due us, grew to almost $4.5b. That's up 25% from December 31 2002. These deferred earnings will be recognized as earned premium in the future, over the life of the related exposures.

Losses and loss adjustment expenses increased to $16.8m. That's up $7.8m from Q4 '02. The quarterly run-rate and loss provisioning has ramped up over the year.

This reflects the significant new business generation during the period, amounting to almost $2.8b in AGP over the last two years. It also reflects that while we'll see an improvement in the general credit cycle, we believe that it will be gradual.

Our net insurance loss reserves at December 31 were $187m, that's a $2.5m increase from September 30. To further break down reserves, our ACR increased $1.4m, to $132m, and our case reserve increased $1.1m, to $54.7m.

During the quarter we paid approximately $14.4m in net claims and loss adjustment expenses. Substantially all of these claims and expenses relate to credits previously disclosed in our case reserves.

A significant portion of this quarter's provision was allocated to case reserves. This was primarily due to updated information and estimates developed from our ongoing remediation process. While they are individual stress credits that are by no means out of the woods, credit conditions in general appear to be on the mend. This is reinforced by a decline in our watch list during the quarter.

Just a comment, in the $14.4m of claims that we paid this quarter, $1m of those claims were actually on a credit that we received a $6m advanced recovery on, basically a recovery in advance of paying the claim. If you may recall, in the prior quarter we booked a $6m cash recovery.

In addition to insurance reserves, we have a $31.3m reserve, which has been established due to mark-to-market accounting on our credit derivatives book.

Moving on to financial services, financial services net revenues, excluding realized gains and losses and the discontinued operations from Cadre, were $10.8m. This is slightly higher than the $10.1m in Q4 '02.

Derivative product revenue came in at $7.3m, that's up from $5.7m in Q4 '02. Our investment agreement business net revenues were down $1.6m from Q4 of '02', basically due to lower interest rate spreads, driven primarily by the low interest rate environment.

As a reminder, we have previously announced the sale of Cadre Financial Services Inc., our investment advisory and cash management business, and have recorded a related charge of $8.4m.

Return on equity, excluding investment and credit derivative gains, and mark-to-market gains that are unrealized in our investment portfolio, came in at a very impressive 16.6%.

In summary, we end a strong year with a solid quarter. Top line production, AGP, was our third highest ever, and financial results reflect the excellent production from the past several quarters.

Before I move on to the Q&A, I'd just like to discuss earnings growth guidance for the year. Our long-term target of core underlying earnings growth is a range of 14% to 16%, and our return on equity target is 15%. We are comfortable with those targets.

Please keep in mind, as we've said in the past, these are long-term targets. Realize that we may exceed these targets or we may miss these targets on a quarter-to-quarter basis, but we are comfortable with these as a long-term goal.

That ends the formal part of the discussion. I'm happy to open it up now to questions.

Our first question comes from Robert Hottensen, with Goldman Sachs. Sir, please state your question.

Yes, a couple of things. The first is that if we look back over the last couple of years, the mix of earnings has been either more revenue-driven, with extremely strong trends in earned premiums, or offset by reserving and expense initiatives, which have offset some of that top line growth if it comes to the bottom line. Presumably, some of these expense initiatives (and obviously reserving is) are on the business-building front.

My question is - in your guidance of 14% to 16% growth in core earnings, how do you see the relationship between some of the reinvestment in building business initiatives balanced versus the revenue growth? Is there any shifting in that mix at all, or do you expect (in your guidance over the next couple of years) to see a similar pattern that we've seen over the last couple of years?

Then I've got a second question.

I think on the revenue mix, Bob, if you look at the trend over (say) the last 18 months or two years, if you look at our earned premium, the international contributed 40% to the growth in earned premium. Domestic structured 31%, and public finance 18%.

I think that as international gets more significant, that number may come down a little bit, but I think that the trend, or the relationships, should hold pretty steady over the next year or so.

Clearly, international is going to be the fastest growing on the earned premiums, then domestic structured number two, and public finance number three. Although I will say that in public finance, we're generating almost $50m per quarter, normal earned premium, growing at an 18% clip.

The writings that we've been doing there at pretty attractive pricing, over the last 18 months, we earned that over a long period of time. We're comfortable that those numbers should be pretty healthy over the coming months.

So my point is that if I take it that your comment on the international is related to the fact that that's probably the area where you've built the biggest business infrastructure, where your expense growth is centered, and so forth. Is your point now, with a critical mass there, having gone on your own several years ago from the joint venture, that we won't see the same trend in expense growth?

When you say expense, Bob, are you talking loss or reserves?

No, really more the actual realization of expenses, and the income statement.

I think that's a fair comment. We're still in pretty good growth mode here, so we will still add resources where we think the revenues justify it. I do think expenses will still continue to grow. However, our goal is to grow earned premium at a rate significantly in excess of the growth of our operating expenses.

Don't forget also, Bob, in 2003 one of the reasons you see expenses growing a little more, relative to 2002, is that we did begin expensing stock options in 2003. There was about $9m of expense in '03 that's not in '02.

If you look at our combined ratio, which is our operating expenses and loss provisions, divided by our earned premium, we came in this quarter at 22.5%. That's actually a tiny bit better than Q4 '02. So we think the fact that the rate we're growing earned premium, versus the rate we're growing expenses, is pretty good.

The second question is, I think you put in the press release (you alluded to it too) that you are looking at the relationship of adjusted gross premiums written, relative to earned premium. I think that relationship is obviously more than two times.

What is the significance of looking at that? Is there any shortcut or back of the envelope expectation, with respect to the trend line in earned premium, given that kind of relationship between adjusted gross premium written and earned premium?

I think that there are a couple of things that are relevant. The way the businesses work now and (as we've said) with international becoming such a large contributor to AGP, and international being lumpy (because the deals are so large and have such long lead times) you're going to see variability in AGP from quarter-to-quarter in this industry.

If you just look at 2003, in Q1 we had $322m of AGP, in Q2 we had $455m, in Q3 we had $283m, in Q4 we had $429m. For the year, it's fantastic, but from quarter-to-quarter you're going to have lumpiness.

The purpose of putting in that number, I think, is that it should bring comfort to folks that two things are happening. One, we're writing business at a significant multiple of the rate that we're earning it, which ensures growth in earned premium. It also ensures growth in our deferred revenue that I talked about earlier.

Our deferred revenue, at $4.5b, grew 25% in one year. If we stop writing business, we have $4.5b of earnings that are going to float through to that earned premium line. So we hope that just gives you some flavor, we wanted to emphasize it.

That number also reflects a very strong refunding quarter. If you looked at that relative to just normal earned, it would be even more comforting, I think.

Okay, well thanks a lot.

Thanks Bob.

Our next question comes from Mr. Geoffrey Dunn, with KBW. Sir, please state your question.

Thanks, good morning Tom.

Hi Geoff.

I just had a couple of questions on the spread environment in your structured market. What kind of pricing are you seeing these days, especially with the appetite for yield and subordinated pieces? If you could specifically comment on the CDO market, since that was such a good place of opportunity for you a year ago.

What's interesting in that market is that what's good one quarter isn't necessarily what's good the next quarter.

As you know, we've got an extremely disciplined approach. We're not going to forgo our 15% ROE target, or our demand for strong credit structures. We're not going to chase those in an environment where subordinate tranche investors get comfortable buying the paper cheaper. We'll let them have it, because the markets are so big, and there are so many other segments for us to play in.

Spreads in that business right now (as I mentioned earlier), in the mortgage sector investors are very comfortable buying the subordinated tranches, and we're seeing more deals go out uninsured. Six months ago, it was just the opposite. If you look at CDOs, a year or 18 months ago we were getting paid extremely well. Then all of a sudden, four or five months ago, spreads come in dramatically, and you can't get paid, so we'd back off.

What's interesting, as we've seen the mortgage market slow down a little bit, we did some very selectively, very attractive CLO transactions this quarter, with the subordination and the structuring that we demanded, and at very attractive ROE. So that market, depending on investor appetite, will vary from quarter to quarter.

So we're seeing good pricing in commercial asset-backed. We've seen good pricing in the (we call it) structured insurance business, a business whereby they're kind of regulatory capital trades, where financial institutions get capital relief by entering into an agreement with us. We're seeing good returns there.

What we are seeing in the mortgage sector is, just like I said, strong competition from senior sub right now.

On the muni front, consensus was that there was a lot of concern about credit note three and that threw up great pricing for you. Is that something that can persist through '04, or have the credit concerns already peaked and now we're declining, and maybe the bullish outlook on pricing is not so intense?

Actually, the good news is that we are seeing some improvement in credit quality in all sectors, but it's gradual, which is the way we like it. In the public finance sector, we're still seeing attractive pricing.

We were surprised with the refunding activity in Q4. If you look at what folks are estimating for volumes, we just came off a monster year, $380b of volume. We think the volume is going to drop in '04, but we still think it's going to be very healthy.

We were predicting in the $300b range. However, as I read in the Bond Buyer (which I know you guys read) just on the 31st, Merrill Lynch and B of A are coming out with estimates much higher than ours, as high as $350b. Nobody knows, but right now we think the refunding piece of the business will trail, but we think the new issuance could still be healthy in '04.

Municipalities are by no means out of the woods in terms of their funding needs, and rates are still pretty low.

Okay, thank you.

Thanks Geoff.

Our next question comes from Mr. Rob Ryan, with Merrill Lynch. Sir, please state your question.

Good morning.

Hi Rob.

Could you do a little more of that roll forward on the unallocated loss reserve for us, and the way to think about it? It was a pretty significant 12-month increase, and that was nice to see.

Is there some kind of benchmark, maybe as compared to the size of the book of business or something, which would help us evaluate the trends that are happening in that number, and where you might like it to be?

Let me start with the roll forward. For the quarter, we put in the $16.8m of provisions for that increase in the overall reserve. Of that provision, about $15.4m of it went right into case.

The reason for that is that we have a very intense ongoing remediation process here. We're in negotiations all the time to recoup claims that are paid, and we get new information all the time. Based on that information, we thought it prudent to allocate the lion's share of this quarter's provision to the case reserve.

I will add, though, that having done that, we are very comfortable with the levels of our case reserves now. So only about $1.4m of the provisioning went into ACR, which is our unallocated reserve, if you will. This brought the ACR up to about $132m.

In general, Rob, a lot of factors go into the analysis of the ACR, including credits that aren't bad enough to be case, but credits that we think it's prudent to allocate a portion of the ACR to.

In general, when you're looking for a ballpark rule of thumb, we have been about 3 to 3.5 basis points of net par outstanding. That's based on a 30-year history of where claims have run over the long-term. That's been the rule of thumb, if you're looking for a rule of thumb.

I don't know if that answers your question.

Yes, that's great. That's the metric that I've been using. On another topic that's been a hot topic this month, and I know you addressed it pretty much immediately after [Radian's] announcement. Could you (for the listeners) just provide a recap of the information you've posted on the website, related to your exposures to manufactured housing?

As Rob said, we did post this on our website, for those who want to see it in detail, but let me give you a summary.

We have four deals, which accumulate to about $1b of manufactured housing exposure. These deals were written in 2001 and 2002. We underwrote these deals at a time when this industry was stressed, and we knew it was stressed. That's when we like to underwrite it, because that's when we get the covenants and protections and pricing that we like.

All of the four deals are performing very well. We do not expect to pay any claims on any of our deals. In fact, one of the deals is still rated AAA, two of the deals are still rated AA, and one deal (the Conseco deal, which is performing very well) is rated A+.

So, once again, much more detail on our website, but we don't expect any issues with those exposures.

Okay, thank you.

Thank you.

Our next question comes from Mr. Mark Lane, with William Blair. Sir, please state your question.

Good morning. This is actually Dan Nazer. As I understand it, there were case reserves on seven deals, at September 30. Did you add any additional case reserves for any specific transactions in the quarter?

I'll answer that question, but we've never really disclosed the number of deals in case I'm not sure where you got that. We added two new deals to case reserves during the quarter. The total amount was $2.5m. All the other changes in case reserves relate to credits that have been in case for a long, long time.

Thanks. I have a follow-up. Looking at your additional loss reserves as a percentage of scheduled premiums, it was up slightly, basically flat, relative to Q3. I figured that Q3 would be a peak level.

Could you just elaborate a little bit more? You mentioned new business ramping up, but then also that you put a majority into case reserves, can you just elaborate a little?

We had a 9% loss ratio for the quarter, and 8.2% for the year, $16.8m was the provision for the quarter.

Based on information we have right now, over the short-term (let's call that the next two or three quarters), my guess is that our loss provisioning will be in that range. So I'm guessing $15m to $18m, in that range for the next six to nine months, barring no new events.

As I said, we are seeing some improvement, but I don't want to overplay that card. We tend to be cautious, and we think the improvement is going to be gradual. I think that should give you a good rule of thumb.

Just to keep it in perspective though, the number gets a lot of attention. It's $16.8m, or $14m in claims. We're running a pretty big business now. We took in $1b of free cash flow this year, we wrote almost $1.5b in premium. When you're running those types of numbers, you are going to see gradual increases.

I think the numbers are quite modest, when you look at it relative to the business production. I don't want you to think that they're going to come down dramatically either, over the next year.

Okay, thanks.

I don't think that they're going to go up dramatically, either, based on information today.

Our next question comes from Mr. Alex Orloff, with Banc of America. Sir, please state your question.

Good morning. I have a couple of questions. The first question is on your international business.

I was wondering if you could provide a little bit more detail, area by area, and by main product lines. Whether some of your expectations, area by area, might have changed in the last quarter, in terms of where you think you'll generate your business in the next 12 to 24 months. Maybe even a longer term, like three to five years.

The second question is, I was wondering if you could provide a little bit more comment on your recent promotions, and the way you see the senior management team shaping up.

First, on the international. I'm looking at the list here. It was actually a pretty diversified group of transactions this quarter.

The two largest transactions, one was an asset-backed securitization, that was the largest transaction for the quarter. The second largest transaction was a transportation deal. There's a mortgage-backed transaction, there's several asset-backed transactions, there's an IOU. So we've seen a pretty good mix.

Where that's coming from, Alex, it's still dominated by Western Europe. The UK, private finance initiative, we are seeing some business in Italy. Actually, we did something in France this quarter, a very well structured asset-backed securitization in France. So we are seeing other markets open. However, the dominant share is still the UK.

Okay.

Regarding the recent promotions. As you know, during the quarter we press-released that we had a few folks who decided to leave the company. One senior manager, a couple of deal guys and an attorney, but we were very fortunate here at Ambac (we've said this all along).

We've got an extremely deep bench, an extremely deep talent pool. Within a week, we were able to fill all those positions internally, with very seasoned veterans. I actually plan to get out and meet all the folks, the analysts, over the short period.

I think you have probably already met some of them. I think you'll be quite impressed. We haven't missed a step.

Great, thank you very much.

Thank you.

Our next question comes from Mr. Kevin Sanders, with Sanders Asset Management. Sir, please state your question.

Thanks. I'm just curious, given the yield curve that we're seeing today, what do your models suggest, at least for a range of refundings in '04?

Kevin, one thing we've learned long ago is that we just can't predict interest rates. We really thought (to be candid with you) that refundings were going to trail off six months ago. The Q4 refundings were just huge. If rates stay low, it really depends on your prediction of interest rates.

If, hypothetically, the curve in six to nine months looked relatively similar to what it looked like today, do you think we would see refundings slow somewhat, but still ...

Yes, if rates were at today's level a year from now, you would still see refundings slow somewhat, because there will be less of the deals out there that are eligible for refunding. Many of them will already have been refunded.

We hope refundings slow down. I know a lot of folks like refundings. They're a blessing and a curse, in that (as you know) we like to keep the business on the books and earn it over time, because if a deal refunds you're not necessarily guaranteed that you're going to get the new refunding business. Many times you do, but you don't always get it.

What's good, though, is the business that's been written in the last two years, in public finance, has been written in a low interest rate environment at very attractive pricing. That business is going to hang around for a long time, unless rates drop further.

Some of the stuff that's been refunded is stuff that was done back in the heyday, when pricing wasn't as good as it is today.

Okay, and just one other question. Given that ROE overall has trended up (I think) in recent periods, I guess it implies that deals in the last couple of years, and even the more recent deals you're getting done, are even more attractive, ROE isn't in your [indiscernible] rate. Is that right? What kind of ROEs have you seen on some of the larger deals over the last couple of quarters?

The business that's being written now, you're seeing a 16.6% ROE. On average, we're writing business better than that. The reported ROE that we give you has been dragged down by the very low interest rate environment.

We have a $7b investment portfolio, it's a third of our revenue, and interest rates are so low that that's a drag on our ROE. So what's making up for it, obviously, is the premium income in the business we're writing.

In general, the more structured deals, I hate to throw out numbers but I'll throw out a range, of in the 20% range. In the less structured deals, in the 13% to 15% range.

Okay, thanks.

Thank you.

If there are any further questions at this time, please press '*' '1' on your telephone keypad, keeping in mind that if you are using speaker equipment it may be necessary to pick up your handset before pressing the '*' key.

Our next question comes from Jerry Smith, with Smith Research and Ratings. Please state your question.

Hi, thanks for the conference call.

Hi Jerry.

I was just trying to understand the currency move that happened this year. Has the strength of the euro, relative to the dollar, has that improved the profitability of your European business? How does that all work, with the dollar-based investment portfolio?

In a very small way, we're not extremely sensitive to currency movements for a couple of reasons. One, in some cases we're paid in euros and pounds, in some cases the deals we write internationally were paid in US dollars. It's still a pretty small fraction of our total premium earns.

We get paid on an installment basis, in (let's say) euro or pound-denominated premiums. At the same time, we have expenses over there that we pay in pounds and euros, so it's kind of a hedge to our expense base over there. There is a small benefit.

Okay, thank you.

Thank you.

Our next question comes from Michael Fletcher, with Lasalle Bank. Please state your question.

First of all, congratulations and thanks for a good year.

Thank you.

Secondly, could you go back over for us what actually gets a deal placed on the watch list? I know you mentioned that the watch list had actually got smaller, which is a good thing, but if you could provide a little bit more color and background on that.

What we do is we have a pretty large surveillance group here. Their job is to constantly review every transaction on our book, on a rotational basis. We do that on a risk-adjusted basis, such that if there's news on a particular sector that may get a bit more focus.

Their job is to be in communication with the clients, look at financial statements. When we write a deal, in many cases (depending on the type of deal), there are reporting requirements that have to be given to us. Monthly, we get trustee statements and monthly or periodically, we get financial statements. Just like a bank, really.

Then they write a report on the credits, we sit around a table (senior management) every month, and we review every one of the credits that have been identified for the watch list. Then we track them. The importance of doing that is that as you know, in the banking world (we're more akin to a bank than we are an insurance company), the earlier you catch trends or problems, the better chance you're going to have to fix them.

We build in a lot of covenants, we build in a lot of protections into our structures that give us certain rights and powers, in the event that (for example) financial covenants weaken, or financial ratios weaken. So we go in and we exercise those powers to protect ourselves.

I'm not sure, did that answer?

Yes, I think so. Is there any time frame though? You're looking at this on a continuous basis, obviously, as you stated, but in terms of placing someone on that watch list, is it over a 60-day period, a 30-day period, quarterly, six months?

On average, I would say we are pretty quick to put it on the watch list if anything negative appears. The reason that we're pretty quick is that this is an internal watch list. We want to have our guys on that immediately, the second a trend appears.

These could be fine credits, but if there's an adverse trend that could give us additional rights and remedies, we want to be on it ASAP. So it's a pretty short time frame, if a trend develops, to get on our watch list.

Thanks a lot.

Thank you.

We will be taking follow-up questions now. Our first follow-up comes from Mr. Hottensen. Please state your question.

Hi. I have a couple of questions on the US public finance market. I think you indicated that the Q4 penetration was 40%, which I think is a big fall-off from where it was in the first nine months. As you look out on '04, actually the penetration is going to be as important, if not even more important, than incremental changes in the volume. Just to get your sense on penetration.

The second question really relates to [Fijic]. A big part of that market was dominated by [Fijic] over the last several years, in which they captured 70% to 80% of the geo-market with very tight pricing, which made many deals uneconomic for anyone other than [Fijic]. Can you comment on whether or not [Fijic] has, in fact, altered its pricing, and whether or not there are opportunities in that market today?

First, on the insured penetration of 40%. That is lower, it was 45.2% in Q4 '02. I think that what's driving that, Bob, is the mix of business that came out in Q4. If you have a high mix of relatively low risk geo, that's going to impact the amount of market that goes to insure it.

So I think that's a bit of an anomaly. I think you'll see that come up in Q1. So we'll keep an eye on that, but I'm pretty sure that's the mix of business.

Regarding [Fijic], it's a little early to tell, but my belief is that [Fijic] had a long reputation of under-pricing the public finance market. They did it for years, and they were pricing business at 8% ROEs. No other public company could do that. They got comfort in [indiscernible]. Somehow [indiscernible] leverage got them comfort, but those are 8% ROEs, they were really something more than that, but on a GAAP basis, they were clearly not.

I cannot imagine that the new [Fijic], with investors that care about returns, can ever write business at that rate, so I think it's going to be a net positive for the public finance market. They're going to have to write business at the same returns that the other major players write it at. It's too early to really see it yet in the market.

So are you now actively working that market with your new business people? Do you have optimism that that represents incremental potential new business for you?

Absolutely. In fact, I'm looking at the list here, and for the first time in a long time we did a very nice large general obligation bond this quarter in our public finance. It was probably [four, five] AGP on the list for the quarter in public finance. That was a general obligation bond.

So what percentage is the GO market of the total US public finance market?

That I don't know off the top of my head, Bob. I can get back to you on that.

I remember, casually, that it might be in the 20% range, or something like that. Depending upon how you define the market.

The point is that whatever it is, that means that in reality the market has expanded by that percentage, simply because if that market was unavailable to you, you now in fact have a bigger market than what you thought you might have had last year.

Yes, we hope so. We hope that will be the case.

Okay, thank you.

Thank you.

Our next question comes from Mr. Dunn. Please state your question.

Tom, I just wanted to follow-up quickly. Has there been any shift in your investment portfolio that might have affected the operating tax rate upward this quarter?

Actually, yes. What we do in our investment portfolio, there's two things that affect the tax rate.

One is the significant growth in earned premium. About 75% of our book are [indiscernible] and tax-exempts, but as our earned premium grows faster than our investment income, earned premium is taxed at 35%. So that brings up the tax rate a little.

However, in the investment portfolio, we constantly look at what's the sweet spot to invest our cash flow in. Sometimes muni's are cheap, and sometimes taxables are cheap. It just so happens here, over the last few months, that taxables have been cheap. So we have been putting a little bit more money into the taxable sector.

We look at this on an after-tax basis. Even on an after-tax basis, taxables have been cheap.

Okay, thanks.

Thank you.

There are no further questions at this time.

Well, thank you very much. Pete, Rob and myself are here all day. If anybody has any questions, or needs to follow-up on anything, please don't hesitate to call us. Thank you very much.

This concludes today's conference. Thank you again for your participation.