Ambac Financial Group Inc (AMBC) 2007 Q1 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Ambac Financial Group Inc. first quarter earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce Mr. Sean Leonard, Chief Financial Officer of Ambac Financial Group Inc. Thank you, sir, you may now begin.

Good morning everyone. Welcome to Ambac's first quarter conference call. I am Sean Leonard, Chief Financial Officer of Ambac. With me today are Robert Eisman, Controller; and Peter Poillon, Investor Relations.

Our earnings press release, quarterly operating supplement, and a short slide presentation that summarizes the quarter's results are available on our website. Also note that this call is being broadcast on the Internet.

Second quarter 2007 earnings will be released on July 25, 2007 at 6 AM, with a conference call at 11 AM. 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.

Highlights of the first quarter. Net income was $213.3 million, or $2.02 per diluted share, down 2% on a per diluted share basis from the first quarter of 2006. As a reminder, in the first quarter of 2006 Ambac recorded a pretax $25 million gain from the sale of aircraft, and the net per share amount was included in all of our earnings measures. I will discuss that transaction a bit later.

While Ambac reports net income in accordance with generally accepted accounting principles, or GAAP, research analysts make certain adjustments to net income to calculate their reported estimates. Therefore to enhance investors' understanding of our financial results, we continue to provide information on the items that analysts adjust out of GAAP net income to arrive at their current estimates. Those items are, net after-tax gains and losses from investment securities and mark-to-market gains and losses on credit, total return and nontrading derivative contracts.

In the first quarter of 2007 net after-tax gains amounted to $2.5 million, or $0.02 per diluted share. This compares to net gains of $8.1 million, or $0.08 per diluted share impact in the first quarter in 2006. On this operating basis earnings per diluted shares were up 1%.

Some analysts also back out the after-tax effect of accelerated premiums earned on obligations that had been refunded and other accelerated premiums. Total after-tax accelerated premiums amounted to $24.7 million, or $0.24 per diluted share, in the first quarter of 2007, which compares to $12 million, or $0.11 per diluted share, in the first quarter of 2006. On this basis earnings per diluted share were down 6%.

Now turning to highlights credit enhancement production, or CEP. CEP, which represents gross up front premiums plus the present value of estimated installment premiums on insurance policies and structured credit derivatives issued or assumed in the period, came in at $310.1 million. That is up 33% from $233.5 million in the comparable prior period.

Now I take you through some details of the production by sector. Public Finance. Public Finance CEP was $114.6 million, up 16% from the first quarter of 2006. Overall market issuance was $104 billion, up about 50% relative to the comparable prior quarter. It was one of the most active quarters in terms of municipal issuance on record.

Total market penetration, which is the percentage of bonds issued during the period with the financial guaranty insurance, was approximately 49%, down from about 54% in the first quarter of 2006. As was the case in the fourth quarter of 2006, the increase in our business production was not commensurate with the significant increase in municipal issuance during the period, as the mix of issuance and very competitive pricing within this segment combined to suppress the level of production.

Looking forward, we do see a better issuance pipeline of more highly structured transactions for the remainder of 2007, including a very active slate of North American project finance deals. However, those transactions are yet to be mandated or awarded, and there is always the potential for such deals to be delayed.

Turning to the Structured Finance sector. Structured Finance CEP was $135.4 million, up 49% from the first quarter of 2006. A broad mix of business was written across various Structured Finance bond types, including strong writings in utilities, structured insurance and pool debt obligations.

Our current quarter's MBS production was approximately flat to the comparable prior quarter; however, we experienced a definite increase in business increase mid quarter as investors became more risk adverse in the sector, driven primarily by subprime concerns. We are seeing stronger demand for our product and better pricing in the subprime and mid prime sectors of MBS, as well in CDOs containing large components of this asset type. We will continue to be selective in the nature of the business we write, and are obviously hopeful that this pricing trend will continue.

International Finance. International CEP within the first quarter came in at $60.1 million, up 38% from the first quarter of 2006. This quarter's international production was impacted by a sizable Austrian toll road transaction, which is the largest European Public Private Partnership transaction outside of the UK to date, as well as strong ratings in the investor-owned utilities sector. Ambac closed deals in six different countries during the quarter, and remain optimistic about our long-term opportunities in the international markets.

Net premiums and other credit enhancement fees earned, excluding refundings, increased to $191.9 million, up 5% from the first quarter of 2006. Public Finance earned premium, excluding accelerations, grew 5%. Public Finance earnings have been impacted by competitive pricing in the segment, the mix of business written, and the high level or refundings in the book over the last -- over the past few years. Structured Finance earned premiums grew 7%. Excellent recent production in asset classes, such as commercial ABS and CDOs, has offset the negative growth trends caused by lowered MBS writings and the high prepayment activity in this sector.

International earned premiums grew 2%, which is a welcome improvement from the negative trends we saw throughout most of 2006. The improvement is driven by the strong production in recent quarters, which has overcome the negative impact of recent run-off and early terminations in the international book.

Accelerated earnings from refundings and terminations amounted to $39.7 million pre-tax in the first quarter of 2007. That is the second-highest level of accelerated earnings in Ambac's history. Three transactions make up about 42% of the refunding balance. Two of those were Public Finance transaction, and one was a terminated International transaction for which we received a make whole payment.

Our deferred earnings representing future earnings on premiums already collected and the future value of installment stands at $6.2 billion. These deferred earnings will be recognized as earned premium and other credit enhancement fees in the future over the life of the related exposures.

Investment income was $112.1 million, up 10%, substantially due to growth in the portfolio driven by strong operating cash flow rather than changes in portfolio yield between periods.

A quick point on other income. Other income in the first quarter was $3.2 million, significantly lower than the $29 million reported in the first quarter of 2006. Included in the 2006 quarter's results is a $25 million, or $0.15 per diluted share, gain on the sale of three aircraft obtained through a previously defaulted transaction.

Turning to some commentary on losses and loss adjustment expense. Loss provisioning amounted to $11.4 million in the quarter compared to $100,000 in the first quarter of 2006. I will now take you through some details on this loss activity.

Total net loss reserves at March 31, 2007 amounted to $226.5 million, up from $215.1 million at December 31, 2006. Total loss reserves include case basis reserves, which recorded for bonds in our portfolio that had defaulted, and active credit reserves, or ACRs.

Case reserves amounted to $37.7 million at March 31, and are down $4.8 million from December 31, primarily due to improved financial conditions in a credit on which we had previously paid a claim and payment activity. Total net claim payments made during the period amounted to negative $100,000. ACR of $188.8 million at March 31 is up $16.2 million from December 31, driven primarily by additional reserves set up for certain Public Finance transactions within the transportation and healthcare sectors. Overall, our exposures rated below investment-grade by Ambac declined by $233 million to about $5 billion, or just slightly less than 1% of our total portfolio.

Below investment-grade mortgage-backed and home equity asset class balance declined $58 million during the period to $790 million. To date we have seen no significant deterioration in our subprime exposure. We attribute that primarily to our selective underwriting of this asset class over the past three years.

I would like to make some comments on the recently issued FASB exposure draft. On April 18 the Financial Accounting Standards Board released its exposure draft of its proposed Statement of Financial Accounting Standards entitled, Accounting for Financial Guaranty Insurance Contracts for Public Comment. Comments on that exposure draft are due back to the FASB by June 18. But Ambac has not fully analyzed the requirements and impacts of the proposed standard, particularly the requirements related to installment paying policies, but we were in the process of doing so.

We do note that that FASB did not address many of the concerns stated in a letter sent to them from the Association of Financial Guaranty Insurers, AFGI. Ambac will continue to work with the FASB towards resolution of these concerns, and we will certainly be commenting on the draft during the timeframe provided.

We believe that until FASB releases a final standard, expected sometime later this year, and its provisions are well understood, it would be premature to estimate the impact on Ambac's financial position and results of operations. Our past financial filings with the SEC discuss the FASB project and the potential for future changes to loss reserving premium revenue recognition and expense accounting. We will be updating that disclosure at our next quarterly filing.

Operating expenses. Gross financial guarantee underwriting and operating expenses for the first quarter of 2007 amounted to $49.2 million. That is down 7% from $52.9 million in the first quarter of 2006. Driving the decline was higher stock compensation expenses recorded for retirement eligible employees in the first quarter of 2006. As you may recall, the first quarter of 2006 expense included the entire 2006 grant for these individuals and a quarter's portion of the expected 2007 grant.

Our Financial Services segment results. The Financial Services segment is comprised of the investment agreement business and derivative products business. Financial Services' net revenues, excluding realized and unrealized gains and losses, were $10.6 million, down 9% from the comparable prior period, primarily due to lower mark-to-market gains included within derivative products revenues during the current quarter. Our return on equity was 14.0% for the quarter on a GAAP basis. On an operating basis ROE was 14.3%.

During the first quarter the Company bought back 4.26 million shares in conjunction with the $400 million debt issuance and accelerated share buyback program. Under the terms of the accelerated share buyback Ambac may be entitled to additional shares at the end of the program. Based on the terms of the ASB to date Ambac would be entitled to approximately 300,000 additional shares. The exact number of shares repurchased will not be determined until the program has been completed sometime in the second quarter. Ambac remains committed to managing our capital structure to a level that is consistent with a triple-A rated company, while maximizing shareholder value.

In summary, Ambac is off to a strong start for the year. Our financial results and business production were very good. Importantly, demand for our product in certain asset classes is as strong as we have experienced in a few years. However, outside of these pockets of spread widening and increasing demand, the environment remains fairly challenging. We will continue to maintained discipline and seek to underwrite those transactions where our superior financial strength, experience and reputation in the market is most valued.

That concludes my prepared remarks. I would now like to open it up for questions.

(OPERATOR INSTRUCTIONS). Ken Zerbe, Morgan Stanley.

A couple of quick questions for you. You mentioned that your MBS transactions or volumes were flat year-over-year, but obviously the problems can't really start until midway through the quarter. Based on your comments, is it fair to say that you would expect second quarter volumes to be up noticeably or materially from last year's period?

Yes, the commentary we had mentioned was with the CEP. The production from quarter to quarter last year this quarter was approximately the same. We are seeing more inquiries there. It is a bit too soon to tell as to exactly what percentage of those transactions we may win, and how they will end up, and what happens throughout the balance of the quarter. But I will say the business activity has picked up there, so we are certainly encouraged by that.

In certain areas we are seeing improvements in price, but that is not fully across the board amongst all the MBS classes, which includes -- by the way it includes home equity loans and other types of products that are in that classification.

In terms of subprime, you mentioned -- make sure I got the wording correct on this -- that your not seeing any significant deterioration in your subprime exposure. Could you just talk -- are you seeing modest deterioration in your subprime or none at all?

At this point in time, and we have very current information -- information, pool information up through the end of March, so very current. And we are able to analyze that on a very current basis and look for trends of the underlying performance. We just haven't seen -- certainly not significant deterioration, as you can tell from the comments I made on below investment-grade. But even within the deal that we have, when you look back at particularly the vintages in 2006 and 2005 where there seems to be more of a market concern with the type of product and the underwriting standards underlying those loans, we're just not seeing deterioration up through March that wasn't expected.

That is not to say though that things can't happen in those pools. But a comment I will make on those pools, particularly in those underwriting years they are characterized by a very high percentage of fixed-rate underlying product. And some of the concerns that I have been seeing in the papers and what not and just reading through press articles is coming from some of the ARM product and the resets and issues with that. So that pretty much summarizes what I wanted to say.

Are there any pools that are running ahead of your expectations, or sort of normal loss expectations in subprime, even if it is not significant, as you mentioned?

I don't have the -- I can't pinpoint it exactly to the individual pool, but my discussion with the folks internally is we have not been seeing anything beyond expectations in the subprime area.

The final question I had, just in terms of the pipeline of I guess Public Private Partnerships in the U.S., from what I thought I understood, I guess pricing on some of the recent transactions has not necessarily been all that favorable, though you mentioned that the pipeline is actually looking fairly robust. Are pricing on those deals improving to the point where you feel comfortable getting into the market there now?

Yes, we feel comfortable with the transactions at certain levels. The transactions we have underwritten we have been comfortable with the levels of premiums that we're getting. They are not as great as they have been, but they are still at an acceptable level.

Heather Hunt, Citigroup.

Congratulations on a good quarter. I guess feeding off of Ken's question, you have said in the past that the number of deals that you're getting submitted to you has been very high in the second half of '06. But those deals just weren't that attractive to you. And of course this quarter you had very strong production. Was the increase in production a function of more attractive deals being submitted, better pricing or a combination?

I think it is certainly -- if you look at it by sectors, it is volumes both in the -- the volumes have been very attractive. Certainly in the first quarter municipal volumes were quite high. And we are seeing those volumes also in the international markets are quite high. But just like previous quarters where we have had good production quarters -- we had two large deals we closed in the international sector. One we mentioned was the Austrian toll road transaction. We had another utility transaction that closed. That represented over 60% of the CEP. We continue to see -- so we are seeing favorable deals as well. We think those deals were good deals.

So it is kind of a combination of the two. When you look on the Structured Finance side we continue to see robust volumes, particularly in the pooled debt obligation, the CDO space. And we have seen a lot of inquiries going into here in the second quarter as well, so we are seeing some nice volumes.

On the CDO side where the underlying collateral is mortgage type collateral, which is a good chunk of that business, we are saying some pricing increases there, particularly in collateral with subprime. So we are seeing some price improvement on that side.

Then on the Public Finance, the competition is still very tough, but there was a nice level of volume in the first quarter.

It seems like security capital, their public finance volume was down and yours was up, but not quite as much as the market though. It sounds like competition was definitely robust there.

Competition is robust. There was -- I would say regarding our volumes during the quarter, we did close a couple of large power transactions. Ambac did lead the monolines in market share in the quarter. One particular transaction, which actually made our top 20 list that we have in our supplement was close to $1.4 billion in par. So that had an impact. And large transactions have an impact on the overall rates. That particular transaction that was a high-grade AA transaction, which was a good transaction. So that kind of drove our percentages up. For instance if you were to take that out, we would probably would have been third in the market.

Mark Lane, William Blair & Co.

Just on the mortgage -- on the MBS side, I just want to clarify what your position is. You have been a little bit more active than most in that space. And with pricing better and potentially terms better, even if it is just opportunistically, why didn't you write more business in the quarter. In the prepared remarks you stressed that you're going to continue to remain disciplined. Are you not ready to get aggressive yet, or have things not changed enough? I am trying to get a sense of what the real message is.

I would say the message there is that we have been disciplined over the last couple of years in the mortgage environment, particularly in the subprime space. So we will actively look at opportunities in the subprime space, but we wanted to meet our particular guidelines -- underwriting guidelines and return guidelines for that particular space. So I would say we are looking at that, and we will continue to pick the best opportunities and the best structures to work from.

I will say we did originate over $4 billion during the quarter. It didn't all come in this subprime space. But we are still actively looking at opportunities there, and have seen good opportunities in that space. So I wouldn't call it necessarily an aggressive strategy. I would look at it as an opportunistic strategy that we would employ.

I'm not suggesting it was aggressive at all. I was more so suggesting it was more than conservative. Assuming that if the market is better, everything else equal, and you're writing the same amount of business. I'm just trying to understand if maybe you have become more cautious over the past year based on what you're seeing than you were twelve months ago.

I would say we are certainly cautious based upon the underlying asset types that we see. We certainly favor in subprime space fixed-rate underlying collateral, because there is some concerns on the ARM side. Not to say that those wouldn't necessarily meet our underwriting standards, but we have favored those types of transactions in that space. So we will continue to look at opportunities, perhaps at higher grade, with that type of asset types. And we're certainly looking at opportunities and have closed transactions on the CDO side with some aspects of that collateral as well.

On the loss reserve side, if you take out the favorable case reserve movement, the addition to the active credit reserve was pretty healthy and kind of more consistent with the approach I would say going back a few years. Where is the underlying book? Do you see the underlying book improvement kind of troughing at these levels, where you're going to more consistently add to the active credit reserve, or are we still developing in the credit cycle where we might see that be below average still in the near term?

I think what you saw this quarter is some additional reserves of items that were already on our classified list. So there's nothing new coming in on to list creating reserve adjustments. So there's nothing new coming in there. Obviously, everything that we know about, we would deal with in the particular quarter, so I would say it is hard to project that. But we feel like we have a good process for evaluating the credits. And we feel like we have captured all the problem type items, below investment grade type credits in that case in ACR reserve.

But do you feel like the ratings migration pattern has sort of stabilized now, given the favorable environment in the last few years, or --?

I would say looking back at changes to below investment grade they have been -- if I recall certainly this quarter it is a relatively small reduction. I believe we have a reduction also in the fourth quarter. So we are seeing some trends there to lower the amounts. It could be due to payoffs, like in this quarter for instance there is a payoff -- mostly payoff activity, but there was one upgrade in the portfolio.

But generally the reserves that we establish normally are driven by a few transactions, so we are not talking a lot of transactions. Obviously that could potentially in the future -- it is hard to project out -- but could be driving some volatility in our reserves, if we do happen to have particular issues, either stuff coming on our list or further deterioration.

Andrew Wessel, JP Morgan.

I guess I have one question about the muni business. It is just, what is your outlook there? Obviously issuance has been higher I think than most have projected in the first quarter. And in terms of looking at the calendar and what you're seeing going out for this quarter, is it similar strength, or was that kind of a blip and you don't expect bonds to continue at that level or percentage insured I guess really to continue at that level?

It is our expectations that the issuance would stay robust and at levels -- I think when we started the year, again I think most folks thought that the issuance would be in the high 300s. So that seems to be consistent with that. I think certainly the environment is helpful in that regard. I think what we saw in the first quarter was a little bit of a dip in rates, so we saw a spike up in refundings, and so there is an element of the volume that might be based upon rate driven concerns rather than new money issuance. But nonetheless, I think it is looking like a -- it has been pretty positive for issuance in the -- for the balance of the year.

My other question has to do with -- if you look back at maybe your view of the market six months ago, and aside from the subprime issues that came about, what has really changed your view of the business and what you think about '07 now versus maybe six or nine months ago what you were maybe expecting or projecting in your own mind?

I think the overall environment is still a tough environment that is characterized by competition and tight spreads. While there might be positive impacts from some subprime as it relates to direct mortgage-backed business and CDO business, it is still -- the overarching umbrella, if you will, of the marketplace is still a tough business environment. So I wouldn't say much has changed other than those specific asset classes. We continue to look for structured transactions and transactions where Ambac has developed a franchise. So we continue to work those transactions, but it is still a difficult market overall.

Darin Arita, Deutsche Bank.

Just turning to actually capital, should the stock continue to trade near or below adjusted book for the balance of year, what would your asset base be for additional share repurchases?

I think that is going to be dependent upon obviously our view of our capital models, business opportunities and potential credit downgrades mainly, I would think. And the impacts of that on our -- what we consider to be our excess capital position. So at this point in time from running our recent capital models at the end of year, I think we continue to feel comfortable with our position, considering the business opportunities out there and the environment for potential downgrades maybe perhaps in the MBS space, I don't know, but generally we feel pretty confident on the capital position.

Saying that though, things can change, and we will be opportunistic as we see those opportunities develop with the overall -- considering the overall environment and our capital position.

I guess just thinking about maybe what has happened then, kind of backwards looking in terms of the first quarter of '07 and the excess capital generated then versus say a year ago, how much more excess capital are we generating here?

Based upon -- all of our capital results haven't been published, but we feel that we're in approximately the same position as we were at the end of last year with the big quarter. If you look back to last year, we had some big transactions that were written particularly in the second quarter. It was a big quarter for Ambac. We had a robust CEP. So we are able to use up some of that capital underwriting business.

Then I guess turning to the mortgage-backed securities book, the runoff of that book has put a drag on premium earned growth over the past maybe a couple of years. Are we at a point where this runoff is turning, and we can start to see this book growing?

I think it will have to -- you look at what happened this quarter. We put on $4 billion -- $4.3 billion approximately in MBS. And I think the overall outstanding par from the end of the year to 331, either stayed flat or down a little bit. So it will have to take growth in originations to really start driving higher than what we have been seeing of late to really start driving that number up.

It just looks like the amount that is running off this quarter -- actually in this quarter is much lower than the runrate in the previous quarters. All right. That's fine. Well, thank you very much.

Geoffrey Dunn, KBW.

My questions have been asked and answered. Thanks.

Al Copersino, Madoff.

I just had a question about the FASB draft. In speaking with the FASB, are they aware that investors are generally, and perhaps even unanimously, opposed to the revenue changes they are considering making?

Yes, they are actually. A number of folks were kind enough to participate in discussions with the FASB. I think generally phone discussions regarding some of their proposals. And my understanding was it was an unanimous disagreement on trying to change the revenue recognition. That was considered, I believe. I don't know how thoroughly that was considered. I think certainly we were disappointed, and perhaps those who participated in those discussions were disappointed as to how that came out.

But that message has been communicated and will be communicated again. And what will happen is probably sometime in July or August there will be what is called a roundtable discussion where folks from industry, public accounting firms, and users of the financial statements or the equity analyst community will be able to in person voice their opinions.

Am I correct in reading the draft as doing harm to the idea of matching revenues and expenses? It seems like you would have to recognize a reserve if there was an issue well before any principal payment was due. Is that correct? It just does a much poorer job of matching revenues and expenses than the current accounting does.

It would match the deferred acquisition costs against the revenues. Both would be back ended. And it would delink, if you will, to a certain extent the loss recognition and revenue recognition. But largely the issue is the way revenue recognition would be recorded, which would be a very, very conservative type methodology.

My last question on this is do you care at all to handicap the odds of this change in revenue going through?

That is funny. I got the same question from our CEO. Yes, that is a difficult one. If you read through the draft of the standard there is -- if you read back in the back end towards the end of it there is some dissenting views of Board members. And the dissenting views primarily go towards the revenue recognition approach that was adjusted. So the FASB, there are seven Board members and they need four votes. So you have two that are not in favor. And you also have one of the Board members rolling off of the Board before this will be finalized. So I would like to remain optimistic. We will certainly do everything we can to express our views and to conceptual issues relating to what they're proposing.

Tamara Kravec, Bank of America.

Just a couple of questions. The first was on refunding. I'm sorry if I missed this, but I know you said that two -- there were two public finance transactions in the quarter. But is there anything unusual happening that is causing higher level of refundings in the public finance markets, just given where straight bond was and what is going on with activity?

My second question is just on Financial Services expenses, it seems to be running a little higher in the last three quarters. And I'm wondering if that is really the runrate we should be looking at going forward?

Overall on the refundings, yes, that was driven by a couple of large refunding transactions. However, we did see some -- it was pretty broad-based across municipal -- the municipal sector. I believe that is caused in the marketplace by a bit of a dip in rates, perhaps some -- of underlying bonds which can be called, but I think generally that was caused by market type events there.

On Financial Services expenses, I know we saw a little bit of a dip up in the first quarter, primarily due to some stock compensation adjustments made towards the end of the year. I think the first quarter number is more of runrate that would be expected through the balance of the year.

Gary Ransom, Fox-Pitt Kelton.

I just have one more question, going back on the pricing and how things may have changed. If we look at it from the point of view of your hurdle rates and the returns that you're trying to get out of each individual deal, I guess I had the impression as we were going through '06 and maybe part of '05 that we were tending to get closer to that hurdle rate, coming down closer to it. Can you say anything about where we are right now, whether we are flat with where we were during '06 or are you seeing some improvements in that using that metric?

We are seeing that metric can vary between transaction, net transaction, internal rates of return and RAROC type measures. Generally though I will say that that has been -- we continue to feel that we're meeting our internal guidelines for return rates. Generally I would say -- characterize it by more of a stabilized rate. However, transaction to transaction it can vary depending upon the complexity and size of the transaction and the nature of the transaction. So there is a wide range there, but I would say generally we have met or exceeded.

If you look at more broad measures of premiums, the CEP to par, I think they're pretty consistent, at least the first quarter was pretty consistent with what we saw for the entire year in 2006. Part of that is being driven by the nature of the public finance business where underwriting has a tendency to bring down that measure. However, the business that we're writing is high-grade business that still meets our hurdle rates of return.

Rob Ryan, Merrill Lynch.

First a question on underwriting expenses and then a unrelated follow-up. I understand the reasons for the year-over-year decrease in the underwriting and operating expenses, but are we still looking at a seasonally strong first quarter for that number, or a high first quarter for that number, and therefore a likelihood of a lower rate going forward for the remainder of the year?

No, I think we should -- in the first quarter if you're looking at particularly compensation and other non-compensation expenses, if you're looking at those numbers, I think those would be -- we are now on a normalized basis, if you will, on the way we treat the retirement eligible folks. So we would expect those to be plus or minus any adjustments we make to incentive compensation. They should be pretty consistent throughout the year.

Regarding premium taxes, those obviously will be -- can be volatile based upon the production of business. And in certain jurisdictions the premium taxes can be three times as high as other jurisdictions, so that number may bounce around a little bit. For instance, Puerto Rico has a premium tax rate that includes the 6%. They get 6%. So it depends on the right transactions. There you might say that number come up and down a little bit.

But overall for what is recognized on the income statement, 36.4 is a ballpark starting point for what we might see in the additional quarters in 2007?

Yes.

Back to the FASB issue. I don't want belabor the point, but if you could give the listeners the benefit of the basic opposition of [ASKI] on the revenue recognition, largely on the passage of time anticipation of risk.

Sure. What the position is, is the FASB -- maybe I will start with what the FASB has proposed and then contrast that with what the industry believes is more appropriate, and what we have been doing.

What the FASB is proposing is that revenue be recognized as the debt service of the underlying bond that we're guaranteeing is extinguished. So as payments are made, principal and interest payments are made, as a ratio percentage of total debt service for the entire bond. So in the most extreme example, if you had a situation where no principal or interest was paid until maturity, no revenue would be recognized until maturity. And then we would recognize the entire premium that we received on that transaction at that point in time. So it is not even -- it would be the last -- it would be on the maturity day, it would be on that date whenever that happened to be. That is obviously an extreme view and what is in the exposure draft.

That is contrasted to where the industry believes is that risk dissipates, if you will, as time passes. So as you get closer to maturity there should be a recognition of that, and premiums should be recognized over the period in which we're guaranteeing the underlying obligation. So there is a passage of time component that would be consistent for recognizing revenue if someone were to actually own the bond and have investment income on that bond. Do there's a passage of time tight notion. That is the fundamental difference between the two approaches.

Drawing an analogy to other insurance businesses, let's say homeowner's insurance or something like that, what is the premium recognition in the case of a policy that is paid upfront on January 1 and it is good for the full year?

Our understanding is they would recognize the revenue over the policy period on an equal basis. They would take January 1, they would take 1/12 of the revenue each month -- of the premium each month, rather than waiting for the end of the policy to recognize all of the revenue.

Even though the hurricane potentially could come in October of that same year leading to the loss.

That is correct. I would point folks -- if people would like to see the industry letter, we would be happy to send that, but that is available publicly at the FASB website. But we would be happy to send that to folks if they would want to see that. Those points that Rob brings up have been described in that letter.

Nandu Narayanan, Trident Investment.

My question is really related to your active credit reserves, because it looks, based on what you're saying, is when you increase it by $15.2 million, but it says it is primarily because of increases in reserves in public finance. What I'm trying to get a handle on is really what assumptions you're using specifically in terms of reserving for your overall portfolio on a going forward basis.

Because in terms of what is going on with the real estate market, we have recently seen even a relatively biased group like the National Association of Realtors actually come out and say that we're going to have the first define home prices, since they started computing the numbers. And it looks like the first national home price decline since the Great Depression.

These are in some ways somewhat unusual times in that respect. From what you have been describing it looks like you have been saying business is difficult more from the perspective of competition on the premium side, rather than any particular problems on the risk side. Could you give me somewhat more specifics in terms of how your reserving? And what are the assumptions you're making going forward in terms of what might be the experience with losses of credit?

Sure. Sure, I would be happy to do that. Two elements of our overall reserves. Case reserves are defaulted items, so that is where we have already experienced a payment default. ACR, which is what you're talking about, is largely driven -- is driven by our classified loan listing, which is driven by an internal process to rate transactions. Largely it tracks below investment grade type exposures. So at that particular point in time when we have internally downgraded the transaction due to a variety of factors, Structured Finance, it could be pooled performance, other items it could be financial performance of an individual enterprise or a project transaction.

When it gets on the actual list, now we would calculate an expected loss largely driven by probabilities of default and loss given default. It would be an expected loss type calculation. And that would pretty much drive the number.

As you would expect, as items get downgraded when you start recording reserves, it would normally be expected that the probability of default would rise. And then as the -- so that is the way we would calculate our ACR. So it is built credit by credit. So we're not establishing general reserves, if you will, for items that you mentioned. We're looking at specific pool performance due to the uniqueness of the transactions and collateral that we have in the pools. It is not a broad basis. It is specific, but it includes a lot of factors in coming up with those -- setting reserves.

So you -- in terms of your overall outlook looking forward then, it looks like what you're describing is a situation where you're looking at -- to some degree backward looking, because you're looking at the actual performance of the loans and using some classifications for this. But then given that, at least in the recent vintage of subprime originations, we have had the very unusual experience of loans defaulting within the first six months. Things we haven't really seen a long time anyway. Do you actually -- if I have to ask you to give me an outlook in terms of what you think for credit for the next six months to a year, what is your perception of what might happen in the market?

That will obviously be dependent on when -- I think happens with some external factors. If you're looking at specific mortgages, it will have an impact of -- it is hard to predict economic events, interest rate levels. One of the points I did make is that the underlying collateral of the subprime is fixed-rate collateral. That is less subject to some issues regarding a resetting of rates and potential pressures on borrowers, particularly when you have housing price declines. So that is something that is hard for us to predict.

While it is looking at information that we have in-house, the information is current. It is pool performance throughout the end of the quarter, so very current information. But there is judgment in the surveillance process when we actually look at the rating of the collateral. So we include a lot of factors in that, and we have expertise obviously in doing that. So it is while it is looking at pool performance, it is not totally restricted to that, and it has some judgment and expertise involved with it.

Heather Hunt, Citigroup.

I guess just a quick follow-up. On the MBS and the below investment grade, I think back in March when we met you were saying that there was $250 million to $300 million that had been called in the cleanup call. And some of that will come out of the loan investment grade. I noticed in looking at your long list of MBS transactions that you have on our website there are a lot that are below 10%. Do you anticipate more cleanup calls on those types of deals?

I would say yes. It is normal practice in that particular marketplace when the pools get to those types of size to clean them up. In situations where that particular call is not exercised then perhaps there is some underlying pool performance issues of what the remaining collateral is, but that would be certainly the expectation of transactions that are performing well.

Mike Grasher, Piper Jaffray.

Just joining here, so I apologize if this has already been addressed. But some of your largest single structured finance exposures are in the student lending business. Has there been any commentary, or have you seen any change in the market there since the Sally Mae transaction or the first Marblehead issues that they have had?

No, we have in fact -- we have actually been meeting on some of the items that are out in the press. We don't think there's going to be -- there might be some business opportunities that develop from that. On the business side there might be some business opportunities that develop from those transactions. On the credit side we don't think there's a lot of the stuff that is going on out in the marketplace, at least at this point, will have an impact on us from some of the Attorney General investigations. At this point in time it may impact on the market.

I know there has been some talk from the government level of perhaps changing some programs that the government is involved with. But my understanding of those proposals that they would be prospective. So we will have to see what develops there, and see how that would impact the market, but at this particular time we don't see major changes.

Jerry Solomon, Bear Stearns.

Two quick questions. I know two years ago you had entered into an agreement to sell Connie Lee, and then you terminated that agreement last year. Any plans to still sell Connie Lee, or is that staying for the time being?

Staying put for the time being. There is no plans.

You may have answered this before, and I apologize for repeating my question or comment. On your consolidated statement of operations the then mark-to-market losses, gains or losses on credit derivative contracts was a negative $5.1 million for the quarter. I know that was in the press release that was netted against other items. Could you detail what that $5.1 million was?

Yes. Our underlying portfolio is an AAA portfolio that, in certain cases, we write in credit defaults swap form. We are required to mark-to-market those transactions. What we saw in the quarters is some widening of spreads on transactions that have some ABS -- mortgage-backed collateral in those transactions.

So we could probably relate that mostly to the subprime type sector?

Yes.

At this time I would like to turn the floor back over to management for any additional or closing comments.

Thank you. Thank you for participating in our conference call. We're happy to answer any additional questions that you may have. Please give us a call here or email us. Thanks again.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. And have a wonderful day.