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Q3 2007 Assured Guaranty Earnings Conference Call - Final
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| Copyright: | CCBN, Inc. and FDCH e-Media, Inc. | | Source: | FD (FAIR DISCLOSURE) WIRE | | Wordcount: | 9756 |
OPERATOR: Good day, ladies and gentlemen, and welcome to the third
quarter 2007 Assured Guaranty earnings conference call. I will be
your coordinator for today. At this time all participants are in a
listen-only mode. We will be facilitating a question-and-answer
session towards the end of this conference. (OPERATOR INSTRUCTIONS) I
would now like to turn the call over to Miss Sabra Purtill, Managing
Director, Investor Relations. Please proceed.
SABRA PURTILL, MANAGING DIRECTOR, IR, ASSURED GUARANTY: Thank you,
and thank you all for joining us today for Assured Guaranty's third
quarter 2007 earnings conference call. Our earnings press release and
financial supplement were released yesterday evening after the market
closed and these materials as well as other information on Assured
are posted in the investor information section of our website. I
would also note that our 10-Q for the quarter will be filed by the
end of the week and will also be available on our website.
On today's call Dominic Frederico, President and Chief Executive
Officer of Assured Guaranty Ltd.; and Bob Mills, Chief Financial
Officer will provide a brief overview of the quarter including
comments about our credit experience. After their remarks the
operator will poll the audience for questions. Please note that this
call is being held for the benefit of analysts and investors and
Assured Guaranty. Members of the media are welcome to listen but are
requested to please call me directly with any questions that they
would like management to address. You may reach me in our Bermuda
office all day today and tomorrow morning at 441-278-6665.
I would also like to remind everyone that management's comments or
responses to questions may contain forward-looking statements. Such
as statements relating to our business outlook, growth prospects,
market conditions, credit spreads, pricing, credit experience, and
other items that are subject to change. Our future results may differ
materially from these statements. In addition, our outlook on these
items may change. For those listening to the webcast please keep in
mind that more recent information on Assured may be available in
later webcasts, press releases, or SEC filings. Please refer to the
investor information section of our website for the most current
financial information on Assured. Please also refer to our most
recent SEC filings for information on factors that could affect our
forward-looking statements. I'd like to turn the call over to Dominic
Frederico.
DOMINIC FREDERICO, PRESIDENT, CEO, ASSURED GUARANTY: Thank you Sabra,
and thanks to all of you on the call and webcast for your interest in
Assured. As all of you are aware the last few weeks have been very
challenging for the financial guarantee industry with enormous
scrutiny being applied to our portfolio compositions, credit
performance, and mark to market calculations. I want to start by
affirming to you that since our inception Assured has believed in
credit discipline, risk management, and financial disclosure
transparency. During these tumultuous times we will continue to
expand our disclosure where possible to meet your requests for
additional information.
Before turning to a discussion of the impact on our credit experience
of our residential related asset exposures I do want to cover a few
of Assured's accomplishments in the quarter and our evaluation of
current business conditions. Consistent with our track record since
our IPO we again made progress on each of our critical objectives as
we have in each and every quarter since our IPO. As we have
previously announced on October 22, Assured posted best new business
production quarter in the Company's history with record production in
our financial guaranty direct segment. We had exceptional production
in U.S. structured finance and very solid contributions for both U.S.
public finance and international. Our transaction count of 90 in the
quarter easily surpasses all of our previous quarterly achievements
signaling increasing acceptance of Assured Guaranty.
Our direct business opportunities continue to expand as our pipeline
at the end of the quarter was again at a record level. We did receive
the long awaited AAA rating from Moody's Investor Services for
Assured Guaranty Corp. on July 11, which we have been able to rapidly
put to use given the widening of credit spreads and the increase in
investor demand for Assured's credit enhancement products. I would
also note that we received our last state license for Assured
Guaranty Corp. from Wisconsin and we are now licensed in all 50
states.
Direct PVP was $133 million, an all time record for the Company.
Public finance production was strong. Due to -- however deal count
was up with our U.S. public finance team closing 36 transactions up
from the previous record of 33 in the quarter. As I mentioned last
quarter we entered the competitive bid market and are making strides
in that large market although our market share is extremely small
providing significant opportunities ahead. Our structured finance
business continues to generate outstanding results with the 68% rise
in PVP over the prior year.
The quarter had a good mix of business and various asset classes,
such as two consumer auto deals, 11 U.S. residential mortgage-backed
deals and 15 U.S. Corporate full-debt obligations and trust preferred
transactions.
On the mortgage side I would note that our activity was largely in
the secondary market this quarter as existing investors sought credit
protection on recent vintage deals. All of these transactions have
been carefully underwritten, with our revised modeling assumptions
including higher loss of varying frequency.
We expect to expand our presence in the flow or new public issue
mortgage business but the current combination of market conditions
and low new mortgage issuance means that there are limited new deals
in the marketplace. I would highlight that we did not underwrite CDOs
of ABS as has been our policy since 2003 and we will maintain that
position. Our direct international PVP was up 23% despite a difficult
comparison to the prior year. Overall the international franchise
continues to develop nicely. We wrote four international pool
corporate or CLO transactions, 17 European prime residential deals,
in addition to five UK utility transactions. I would also note that
we are the lead sponsor of the upcoming Australia Securitization
Forum and recently signed a lease to open an office in Sidney in
conjunction with the conference at the end of November.
Our reinsurance production results were also good at $32.8 million.
As we have stated in the past the impact of large deals tends to
exacerbate the volatility of recorded production in our facultative
business which is the principle growth driver of this segment.
Facultative PVP comprised 67% of total PVP in the quarter and 61%
year-to-date. This is in accordance with our strategy. I would also
note the prior year's quarter is the last quarter in which we
recorded any material PVP from the Ambac treaty which totaled 9.5
million in last year's quarter.
Let me now turn to the credit discussion. As many of you are aware
Assured has always taken a conservative underwriting approach. This
is currently manifested by our lack of material exposure to several
distressed asset classes which has put us in a very solid position
compared to the industry given rising concerns about U.S. RMBS and
related credit exposures. As you know, we have not written CDOs of
ABS since 2003 and the 2.2 billion of remaining exposure that we have
in that asset class which is rated all AAA with static pools of AAA
rated collateral is performing as expected. None of the collateral in
those transactions have been downgraded by any rating agency or by
Assured. Performance has been strong and does not suggest any
potential losses.
On a more granular level in this class we have only one exposure
where a sub prime residential mortgage exposure represents 32% of the
collateral pool. All of the collateral is still rated AAA today.
Additionally this specific CDO exposure expires in April of 2008.
Fitch recently recognized the strength of our capital base and our
solid risk profile when they announced this Monday that they were
beginning a capital analysis project for the financial guaranty
industry. In this announcement they bracketed the guarantors by
probability of potential additional capital requirements to maintain
their Fitch AAA ratings. Assured was only one of two companies to be
identified as having the least exposure to additional capital
requirements from this new study. This was due to our negligible
exposure to CDOs of ABS and the high credit quality of our mortgage
book of business.
As we disclosed in our financial supplement and press release our
portfolio continues to be highly rated based on our own internal
rating standards. Which generally results in ratings at or below the
rating agencies shadow ratings on our par insure. While market
opportunities have expanded we have maintained our underwriting
standards across all asset classes. Our total net par outstanding
continued to have an average rating of AA minus with over 40% of
outstanding par rated AAA based on these internal standards. Our
below investment grade and CMC list decreased again this quarter to
the lowest level on a dollar and percentage of par outstanding basis
since our IPO.
During the quarter we continue to be very selective ensuring that all
deals written meet our stringent standards that have been updated to
reflect current market experience in certain asset classes.
Specifically our assumptions for frequency and severity for RMBS
exposures represent a current stress view of recent market
conditions. 77% of the business written in the current quarter was
rated AAA. Our U.S. RMBS book totals 16.4 billion is spread across
four types of asset classes, prime, alt A, HELOC and sub prime. While
underlying mortgage delinquency and foreclosure severity have risen,
and we expect them to continue to rise, our policy of AAA attachment
points on sub prime since our IPO has provided us with excellent
credit protection. Our post-2003 direct sub prime book currently has
an average over collateralization of 39% and our current conservative
expectation is for cumulative losses of 14 to 15%.
We recently did an updated break-even analysis on each transaction
and we determined that the underlying cumulative losses would need to
rise on average above 29% of the original pool balance before we
would incur losses. Cumulative losses on the underlying collateral in
our transactions thus far have been only 1%. More recently we've been
focussed on an examination of our HELOC book of business which
totaled $2.5 billion at September 30, 2007, of which $1.6 billion or
65% is in the direct segment and the remainder is in the reinsurance
segment.
In the direct segment we have a short list of transactions, only
seven deals with three different services. 91% of the exposure is
with Countrywide and the preponderance of that exposure is in two
public deals. Countrywide HELOC, 2005 J where we underwrote classes 1
and 2 in the fourth quarter of 2005 and Countrywide HELOC 2007 D
which we underwrote in the second quarter of 2000 under tightened
underwriting standards. You should note that we did not write any
direct deals in 2006 due to our concerns about terms and conditions,
such as the use of HELOC as piggy-backs seconds that are used to buy
investment properties and the general deterioration in first and
second lien underwriting standards. We also stopped writing
facultative reinsurance on HELOC business early in 2006 for our
reinsurance book.
To date our direct HELOC exposure is experiencing increased
delinquencies and we have not paid any losses. Our 2005 and 2007
Countrywide transactions which have public data on Intech have
experienced a spike in collateral losses in September and October,
but still have significant credit enhancement remaining. Additionally
SX spread which may be higher than originally expected due to the
slowing of prepayment speeds is being used to fund future losses and
any excess will be used to build up further credit enhancements. We
continue to closely monitor our performance and stress test the
remaining losses. Even in high stress scenario, losses if any are not
expected to be material given the modest level of our exposure and
the level of credit support engineered in each transaction.
In summary, Assured's portfolio of RBS risk will experience some
credit stress compared to original expectations, principally in our
HELOC exposure. But in most instances we continue to believe that the
probability of meaningful loss which we would define as an aggregate
loss of $100 million is extremely remote. We're completely fluent in
the details of our portfolio and we will continue to keep you
appraised of our experience as the pool of insured mortgages
continues to mature.
Finally, through all the crisis and stressful experience over the
past few weeks a few further observations can be made. First, Assured
has clearly demonstrated underwriting principles and competency in
this market and has garnered broad market acceptance. Secondly, the
market will reset itself as we pass through these challenging times
as to our trading differential to our peer companies. An incredibly
critical element of our strategy and future success. We believe based
on a host of factors including the current credit default swap prices
for the entire financial guaranty industry that we should
significantly accelerate our time frame for trading parody to our
longer established peers. This will have a significant impact in
terms of production, profitability, and capital. Now I'd like to turn
the call over to our CFO Bob Mills who will discuss the financial
results of the quarter in more detail.
BOB MILLS, CFO, ASSURED GUARANTY: Thanks, Dominic and good morning. I
want to remind everyone to refer to our press release and financial
supplement for segment level details and further explanations of our
financial position nd results and operations.
Now, turning to our performance for the quarter. Operating income
which we calculate as net income excluding after tax realized gains
and losses on investments and after tax unrealized gains and losses
on derivative financial instruments, for the third quarter of 2007,
is $48.2 million or $0.70 per diluted share compared to $39 million
or $0.53 per diluted share in the third quarter of 2006. Assured had
a net loss for the third quarter of 2007 of $115 million or $1.70 per
diluted share compared to net income of $37.9 million or $0.51 per
diluted share for the third quarter of 2006.
Let's look at the results for the quarter in further detail. PVP or
the present value of gross written premiums totaled $165.5 million
for the quarter, up 30% compared to $127.4 million for the third
quarter of 2006. PVP for the direct segment was $132.7 million for
the quarter, up 46% from the third quarter of 2006. And was the
principal contributor to the Company's record PVP in the quarter.
Production in the direct segment included strong performance across
all sectors of the business as widening spreads resulted in increased
demand and improved pricing. PVP for the reinsurance segment totaled
$32.8 million, a decrease of 10% from the third quarter 2006 amount,
of $36.5 million which was largely due to the non-renewal of the
Ambac treaty which had generated PVP of approximately $9.5 million in
the third quarter of 2006.
As Dominic mentioned, facultative activity was the principal source
of new business in the quarter rising more than 100% over that of the
prior year. Net earned premium for the quarter total $56.2 million up
8% from the third quarter 2006 amount of $51.9 million. For the
financial guarantee direct segment net earned premiums totaled $31.7
million for the quarter, compared to $21.8 million in the third
quarter of 2006. An increase of 45% from the prior year. Which is
reflective of the overall continued expansion in our direct book of
business. As well as $1.1 million in refunding net earned premium
from a U.S. public financed transaction. Net earned premiums for the
reinsurance segment were $21.6 million, a decrease of 15% from the
third quarter 2006 amount of $25.4 million. The decrease was the
result of decreased refundings as well as the fact that a number of
shorter dated structured contracts are maturing while much of the
recent business has been longer dated contracts. Net earned premiums
for the mortgage segment were $2.9 million down from the third
quarter amount of $4.9 million in 2006. The decrease reflects the
continued run-off of the business in this segment during the quarter
as well as a $900,000 premium received in the third quarter of 2006
due to a commutation of a reinsurance agreement. There was no new
business written during the quarter as was our expectation.
Loss and loss adjustment expenses incurred totaled $3.7 million for
the quarter, compared to $0.9 million for the third quarter of 2007.
There was a net increase in case loss in LAE reserves in the
reinsurance segment related to aircraft transaction underwritten
prior to our IPO, but no major changes in other case reserves. The
largest item impacting the expense for the quarter was the updating
of rating agency severity factors in our portfolio reserving model
based on recently issued data which totaled $6.4 million.
The investment portfolio increased $149 million from the balance as
of December 31, 2006. The result of normal operating cash flow.
Yields were up slightly comparing the third quarters of 2007 and
2006. With pretax book yield of 5.2% at the end of the current
quarter, while we increased the duration to 4.4 years. There has been
no significant change in the investment portfolio asset allocation
during the quarter. And the average credit quality for the portfolio
remains at the AAA level.
Operating expenses increased by $3.4 million or 21% in the third
quarter of 2007 compared with the third quarter of 2006. The increase
was attributable to a number of factors including expanded head count
since the end of the third quarter of 2006, as well as expenses
related to share grants vesting over a four-year cycle and
share-based grants to retirement-eligible employees which are
recorded on an accelerated basis. The level of all other operating
expenses remained relatively flat in the third quarter of 2007, and
continues to be in line with our expectations. Income taxes on
operating results for the quarter were a recovery of $1.3 million.
This is the result of a $6 million reduction in our estimated U.S.
Federal tax liability due to the finalization of an IRS audit
associated with 2004 and before for some Assured's subsidiaries.
Absent this recovery the effect of tax rate on operating income was
10% for the current quarter.
As many of you are aware, financial guarantee contracts that are
written in credit derivative form must under U.S. GAAP be mark to
market and provide protection against payment default on underlying
security, not a change in market value. As disclosed in our press
release dated October 22, 2007, we had after-tax unrealized losses on
derivatives of $162.9 million. This was totally attributable to
spreads widening and included no credit losses. The derivative
business is an extension of our financial guarantee business and
these guarantees and derivative form are not traded nor are we
generally required to post collateral based on changes in market
value. As these instruments approach maturity, market fluctuations,
gains or losses will revert to zero, absent its specific credit
event. Changes in the mark to market have no impact on statutory
capital or rating agency models .
More than 70% of the mark to market was due to our corporate CLOs and
in particular our high-yield corporate cash flow CLOs, 100% of which
are rated AAA. I would note that the widening of spreads in the CLO
market is due to mismatch of supply and demand in that market, as
underlying corporate credit performances remain strong. The balance
of the mark to market was mostly attributable to the decline in sub
prime secondary market prices for our RMBS and commercial MBS book
which is almost entirely rated AAA.
The net position on the balance sheet related to the mark to market
of derivatives as of September 30, 2007, is now a liability of $202
million before tax benefit. With considerable volatility continuing
in the market, this amount will fluctuate in the future periods.
There has been little movement in the mark to market since September
30, for corporate CLOs, the largest component of our mark. I would
note that the sub prime market prices have continued to deteriorate
since the end of the quarter. The actual mark to market for the
fourth quarter will of course depend on market prices as of December
31, 2007. You should note that our 10-Q, which will be filed shortly,
will include a sensitivity table for mark to market valuations which
should provide some clarity into our mark to market valuation level.
Our book value per share was $23.69, a decrease of 1% from the $24.02
book value per share at the end of the third quarter 2006. Our book
value per share number includes about $2.20 a share for the net
unrealized loss on derivative contracts as of September 30, 2007.
Adjusted book value which reflects the book value and adds the
embedded value from after tax net present value of estimated future
installment premiums in force, and after-tax net unearned premium
reserves net of debt was $37.57 per share at quarter-end, up 9%
compared to $34.43 per share at the end of the third quarter of 2006.
The growth in adjusted book value reflects strong new business
production over the last 12 months. It was partially offset by the
mark to market unrealized loss on derivatives.
The Company's operating ROE which is calculated by dividing our
annualized quarterly operating income by average shareholder's equity
excluding accumulated other comprehensive income in the effect of the
unrealized mark to market loss was 11.4% in the quarter and
year-to-date compared to 9.4% for the third quarter of 2006 and
year-to-date to 2006. With that, I'd like to turn the call over to
the operator to poll for
OPERATOR: (OPERATOR INSTRUCTIONS) Your first question comes from the
line of Geoffrey Dunn with KBW. Please proceed.
GEOFFREY DUNN, ANALYST, KBW: Good morning. We're hearing some
feedback out there that the rating agencies are getting maybe a
little overly aggressive on downgrades, not necessarily looking at
full transaction merits but maybe basing down rates just on
collateral performance. I'm in the camp, I don't think you're going
to have material losses, nor do I think any of your peers will, but
incrementally do any of the rating agencies actions worry you that
maybe more indiscriminate downgrades could pressure capital charge
requirements inside the Company with losses not really being an
issue?
DOMINIC FREDERICO: Jeff, our view is we rate everything internally so
that the rating agency ratings are kind of like a, either secondary
check guidepost but principally we rely on our own ratings, we assess
our own capital requirements off of that. Although, as you point out,
we're subject to their current requirements and that is why our
current conservatism over our capital, because quite honestly we
don't know where this is going to go relative to capital needs based
on the downgrading and then their stress modelling. So we don't have
an influence of our underwriting that is done off our internal
structure and system and standards. We are mindful of their current
concerns and potential reaction to the current market and, therefore,
position the Company to ensure that we have the capital required to
continue to maintain very strong levels of AAA ratings.
GEOFFREY DUNN: Right. Thank you.
OPERATOR: Next question comes from the line of Mike Grasher with
Piper Jaffray. Please proceed.
MIKE GRASHER, ANALYST, PIPER JAFFRAY: Good morning. Dominic, you
mentioned some discussion there on trading differentials. Where are
those differentials now, how have they changed over the past 90 days?
DOMINIC FREDERICO: Mike, we've had historically been pulling in the
trading differential and it probably starts back two years ago as we
started to move up the ratings scale in terms of the AAA ratings.
It's harder to now provide real points because there is not a lot of
transactions being done. On the structure finance side, we have no
real side by side comparisons, but market participants typically
point to the default swap levels and we are quickly becoming a
preferred provider and we there with price are very close. Obviously
the real issue for us and the real opportunity is in public finance.
And in public finance we've been able to get to a position of parody
for floating rate but the Fitch rate, and this goes back to the issue
of how many transactions we're going to actually be able to point to.
We're currently in a rating or a differential of about 5 to 7 points
and yet obviously our argument is extremely powerful relative to the
rationale as to why we should be trading flat, if not inside, by
point to go a whole host of different data points, including the
credit default swap prices for ourselves against those other
guarantors. So as I said in my opening comments, there is our
expectation that this market should reprice, it should reprice
significantly in our favor, and that being the case, even though it
takes some time, that will provide us tremendous opportunity for the
Company to grow in that very valuable asset class called public
finance.
GEOFFREY DUNN: It leads me to my follow-up. Which is how much has the
market changed for Assured and what does your pipeline look like
today? Has it accelerated given the current environment?
DOMINIC FREDERICO: Our pipeline today as I said earlier, is at record
levels, and I would tell you that it is at record levels almost at a
multiple. So we don't typically give out the exact number. The only
thing I can say to you is on a year-over-year basis we look like a
very different Company. You're looking at in terms of just giving you
a quantification, triple what it was last year at this time.
GEOFFREY DUNN: That's helpful. Okay. Thanks. And then, Bob, just I
wanted to I guess pry you a little bit here, as a former banker,
there seems to be a lot of confusion out there around the mark to
markets between the banks and between the financial guarantors. Can
we get your thoughts in terms of what some of the -- where some of
the confusion may lie in terms of how the banks perform their mark to
markets versus what the financial guarantors do?
BOB MILLS: It is somewhat difficult to comment on what each bank is
doing, since I am not in there. Certainly I worked on that side of
the fence, too, and I believe the discipline or the mark to market
concept is the same, regardless of where you are. From the mark to
market standpoint I believe we use a rigorous approach to this to the
extent that we can we use direct quotes. Beyond that, we rely on
market indices, the JPMorgan high-yield cash flow, AAA index for our
high-yields. The ABX index and CMBX index for our residential and
commercial mortgages. Beyond that it becomes more limited use of
counter-party marks or similar transactions, but that is very
limited. You must remember, too, that 97% of our CDS are all AAA
rated. So it is hard to comment on what the others are doing. I do it
the same way as I did when I was on the bank side. Use a very strict
methodology.
DOMINIC FREDERICO: I'm going to step out on a big limb here and get
on a little bit of a rant. Part of what you're seeing in the hysteria
in the market today I believe is because of the mark and the
misunderstanding of the mark relative to financial guarantee
companies. We're not priced on a spot basis, we do not have exposure
relative to a change in price, we pay only on credit events. A
significant portion of the mark deterioration today comes out of the
residential side. We've gone through in this call in our website an
exhaustive explanation of our exposure. We've quantified for you the
worst possible maximum exposure we have. It has nothing to do with
our mark. Our biggest exposure today that we believe that could
result in losses is HELOC exposure which is not even in the mark
because they're financial guarantee contracts. The mark is not a
surrogate for losses, it can't be looked at that way, each of us has
to come to recognition of our exposure relative to the residential
marketplace as it is today and recognize there is potential losses
period, end quote and the market is not relative at all to that
discussion.
MIKE GRASHER: Thank you for that feedback, that's helpful and
hopefully the market will figure it out some day.
DOMINIC FREDERICO: We hope and pray along with you.
OPERATOR: Your next question comes from the line of Darin Arita with
Deutsche Bank. Please proceed.
DARIN ARITA, ANALYST, DEUTSCHE BANK: Good morning. Good morning. I
was hoping to talk more about your HELOC exposures. Can you give us a
sense of what cumulative losses those can sustain, what happens if
prepayments slow and then also give us a sense of the -- what sort of
stress testing you put these through?
DOMINIC FREDERICO: Okay. Darin, this is an extremely complicated
exercise, because there are so many assumptions that go into the
ability to forecast expected outcomes. So if you think of the result,
these are basically second, the HELOCs, they sit on top of prime. So
the first thing you really have to understand what are the mortgages
below you, the type of loans they are, because that has an impact on
the second position. We look at that in items of starting to develop
our expectations of what I'll call default factors, right, so that's
delinquencies that ultimately confer to a default. We do stress it
significantly beyond by looking at today's current array of current
borrowers, delinquents, and stress each class to an assumption of how
much will go into default. For the sake of argument everybody above,
say, 180 days we consider even though they're only delinquently
listed today, they're 100% going to go into default. We then also
further stress it by saying that everything is 100% severity, there
will be no recovery. Every time we look at our expected loss in that
model we take the worst position.
The real wild card here is the excess credit, these deals start out
with virtually no overcollateralization or credit enhancement and it
is built up by the trapping of the excess spread. So you hit the
pre-agreed level of credit enhancement. As prepayments slow the
amount of excess spread which is typically in excess of 200 basis
points then continues to build. It pays losses as well as builds up
additional protection. That is the wild card today. We normally
assume a prepayment rate, kind of in the 30% level. And based on what
we're seeing today, that's starting to slow down, so probably down to
a level of 15, that has a significant impact on the level of buildup
of credit enhancement.
We think our deal structure today can absorb a loss somewhere in the
8 to 12% range of the original pool balance. Current default or
current losses today in the structure are at 1.4%. The 2000 deals are
written --2007 deals are written even tighter so there we think we
can get up to as high as 14% enhancement before we would ever be
looked at to pay a loss. Also remember these are spread over seven
deals, so they're not huge in and of their own right. For instance,
if you look at the Countrywide deals with roughly about 700 million
of par still outstanding, 1% movement above our expectation of loss
containment is a whopping $7 million. So as you can see, even if our
expectation is it will go to 10, and we cover it. If it goes to 20,
that's $70 million of impairment before tax.
So we look at it tight. We try to estimate as best we can the
negative side which is the foreclosures and the severity, which we
take very conservative views. The wild card is how much continued
enhancement we will build from the excess spread and that is really
related to the prepayment factor. We look at that at 30% now, we
think it's probably really around 15. As that modifies it will give
us more enhancement to protect losses. But as I said, even in the
absolute expectation of, it doesn't come out the way we think,
everyone points about $7 million.
DARIN ARITA: That's very helpful, Dominic. I guess turning to a
different subject, on reinsurance, if some of your competitors do
come under capital pressure and they're looking for ways to free up
capital and they seek reinsurance as a solution, would Assured
Guaranty be willing to offer that?
DOMINIC FREDERICO: My gentleman who runs the direct businesses is
madly scribbling on a pad of paper that we would rather not. We are
committed to both sides of this industry, both on a reinsurance side
and a direct side. We will be opportunistic on how we utilize out
reinsurance capital. The current market, as you point out, should
send a lot of the existing guarantors to seek reinsurance protection.
We're aware of that. That becomes in effect our market, and that's
kind of why we're here and that's what we're built for.
DARIN ARITA: Great. Thank you very much.
DOMINIC FREDERICO: You're welcome.
OPERATOR: Your next question comes from the line of Mark Lane with
William Blair & Company. Please proceed.
MARK LANE, ANALYST, WILLIAM BLAIR & COMPANY: Good morning, everyone.
DOMINIC FREDERICO: Good morning, Mark.
MARK LANE: Congratulations on getting that last state license in
Wisconsin, by the way.
DOMINIC FREDERICO: It was a significant point, Mark. I wanted to make
sure you understood that.
MARK LANE: I've been waiting for that.
DOMINIC FREDERICO: We passed out cheeseheads this morning.
MARK LANE: My question is, on excess capital, I don't know if I
missed it, but Bob, can you talk about, quantify that potentially, at
least within a range based on the different ways of the way rating
agencies look at that?
BOB MILLS: Yes, it's -- it is done differently by all three rating
agencies. And , when you look at the -- their last published data,
the excess capital would be, depending upon who you're looking at,
somewhere between 300 million and $685 million depending upon which
which rating agency you're looking at. So there is quite a
substantial amount of excess capital that still exists
MARK LANE: And, while your credit quality is extremely good on the
RMBS side, can you give us any sense of the -- what sort of downgrade
risk in terms of capital requirements you might have?
BOB MILLS: I mean not surprisingly, we have looked at downgrade risks
associated with our sub prime and prime exposure and we clearly have
enough capital under a reasonably severe downgrade scenario from --
for sub prime, and we're prime exposure from any of the rating
agencies at this point. I don't see it to be a big problem.
MARK LANE: Okay. The last question is -- and I don't know if there
has been enough time--the market has been kind of seized up, but
regarding the business on a day-to-day basis, I don't know, you
mentioned trading differential, but what is the dialog right now
among your customers, their comfort with the financial guarantee
product right now? At least anecdotally what sort of discussions are
you having? Are you concerned at all about wavering demand or just
the scrutiny on the business? Is it -- has there really been a change
in the last week or two, or is it just more rumors and et cetera.
DOMINIC FREDERICO: The biggest change, Mark, obviously we're
committed and believe in the industry and its viability and its
necessity in today's capital markets as a means to accomplish
financing that would not get done in any other format. If you look at
dialog, obviously the easiest thing we can point to is our pipeline.
As we said it is triple what it was last year, and no one is walking
away from the table. Deals are getting postponed due to liquidity
crisises. But it separates the market. International goes on as it
goes. Public finance goes on as it goes. It is really in the
structured credit where true cash deals, or public deals, are drying
up for the short-term as liquidity has kind of left the market.
However, there are tremendous opportunities relative to basically on
balance sheet risk management that are kind of filling up our
coffers. And the neat thing about this business is it really gives us
the ability to choose the asset classes.
Obviously going forward, as the market works its way out, some of
these , non-bank SIDs will obviously go away and that is not a real
loss for the industry. Obviously we don't expect CDOs of ABS to be a
very popular item going forward. Once again, since we didn't write
any of that business, it is not a concern of ours. Are we necessary,
absolutely, are we involved in active dialog with all of our
constituents out there in the marketplace? Yes, we are. Is there a
lot of activity today? Sure there is. But there are segments of the
market that because of liquidity crisis, which we do believe corrects
itself. At the end of the day these things have to ultimately get
taken care of in the market. We are, I would say, on the lips of most
people that are looking for credit protection as one of the premier
guarantors that they want to do business with on a go-forward
MARK LANE: Last quick one, Bob, the portfolio reserve is in direct.
You mentioned some change in rating agency distressed analysis or
something. Which rating agency or which sector are we talking about?
BOB MILLS: I mean, we do this every year. But on September 6t,
S&P put out some new severity information for ABS, and we put
that new information, as we always do, into our model, and that
resulted in an increase in the portfolio reserve as I said of $6.4
million.
DOMINIC FREDERICO: Remember, Mark, we do portfolio reserves on every
risk in our portfolio. It really keys off of default assumptions and
severity assumptions that we use published from the outside, so it is
very independent. It is the S&P, default and severity, and
because they changed as of September 6, which they typically do every
year in the third quarter we then update our statistics, so when our
machine runs our portfolio reserve has the higher severity.
Principally with severity this time. Higher severity risk that caused
us a $6.4 million increase in reserves.
MARK LANE: Got it. Thanks a lot.
DOMINIC FREDERICO: No problem.
OPERATOR: Your next question comes from the line of Jeff Bernstein,
with (inaudible) please proceed.
JEFF BERNSTEIN, ANALYST: Hi, very similar question to the one before
but I'll ask it again, I guess it is from your customers' standpoint.
With what is going on in the press, the equity markets, and your own
CDS levels, how does the customer remain comfortable that it is a
good decision given the way the market -- and I agree it is
irrational, but the way the current is currently valuing you and your
peers, both equity and fixed income?
DOMINIC FREDERICO: Well, it is kind of a, almost a parallel shift.
Right? So our spreads have widened in terms of default pricing, but
in most cases on the ABS side, so have the underlying assets. So
since both of why now the amount of benefit that you're going to
achieve from us providing the rap is still providing the benefit.
Number two, people, although we bring around those credit default
swap prices table with us, we see certain that desks in terms of
pricing our risks they are not that widely adhered to or used in the
current argument. So we still provide value, we still provide the
access to the capital markets in liquidity. And, therefore, we're not
having those kind of halting conversations that you might expect
based on the other kind of noise that is going on today in the
marketplace.
JEFF BERNSTEIN: Thank you.
DOMINIC FREDERICO: You're welcome.
OPERATOR: Next question comes from the line of Heather Hunt with
Citigroup. Please proceed.
HEATHER HUNT, ANALYST, CITIGROUP: Thank you and good morning.
DOMINIC FREDERICO: Good morning Heather, how are you.
HEATHER HUNT: Fine, how are you? I wonder if you could talk about the
dynamics of your new business this quarter? It looks like you went
towards more conservative products, given that your premiums to par
didn't really increase very much, and just looking on the schedule it
looks like more GOs, et cetera. Can you describe why you've moved
toward that? I am assuming it is because you can get better pricing
for lower par. But it would seem like you could get some really good
pricing this quarter.
DOMINIC FREDERICO: Heather, as we talked a little bit about our book
will start to transition as our current AAA ratings across the board
take hold. Where we're going to be able to see more of that
traditional, very safe business. Remember, in the old days we were
under a market share requirement from Moody's which we've always
taken strong exception to in terms of financial separating. It forced
us to write high par, low premium but we never skimped on the credit
quality. So we wrote those AAA attachments. Today we've able to look
at a broader mix of the business and all asset classes, yet for us in
today's market, we're being very conservative on how we utilize that
new-found pricing power and those areas of the market that we're
willing to put our capital at risk, because part of it is we believe
there are significantly better times ahead, part of it is you
definitely walk before you run, and that we're building up our
diversification of the book or the portfolio, as well, across these
kind of new areas that we haven't previously written before. And we
obviously handled the opportunities we get and what our marketing
efforts have provided us. That will continue to evolve and change
quarter to quarter.
HEATHER HUNT: Okay.
DOMINIC FREDERICO: The book is, if you had asked me a year ago,
post-AAA, what would be the mix in terms of rating of your business,
I would say we would be moving out of the AAA world. We see no reason
to do that at this point in time. You're getting paid very, very well
for taking that very high rated, very safe level risk. Preserve
capital. But at the same time move up profitability and overall
production. So it is a good part of how we're looking at it today.
HEATHER HUNT: Okay. I thought it was something like that. And are you
seeing opportunities in the last few weeks to maybe do deals where
some of your competitors who are a little bit more in the headlines
are not as active, just in the last few weeks? Is there at all a
change in the tone?
DOMINIC FREDERICO: We are doing a lot of secondary deals, Heather,
exactly as you pointed out. And one of the comments underlying Bob's
remarks on mark to market exposure, some of our current fluctuation
potential mark is relative to the swap pricing on our peers, and how
it is going to affect the mark. So we are doing a lot of rap on raps
if that is your question.
HEATHER HUNT: Thank you very much.
DOMINIC FREDERICO: You're welcome.
OPERATOR: Your next question comes from the line of Tamara Kravec
with Banc of America Securities.
TAMARA KRAVEC, ANALYST, BANC OF AMERICA SECURITIES: Good morning,
everyone.
DOMINIC FREDERICO: Good morning.
TAMARA KRAVEC: Couple of questions. The reinsurance transaction, the
HELOC, the 1.8 billion, any thoughts on risk of further downgrades of
that or do you think it has been reviewed and that's it? And then on
the reserve increase in the direct business, just a follow-up to
somebody's question about what -- how different now do you think your
severity assumptions are, were you just kind of moving through rating
agency assumptions or did you take an extra look at it and move even
more conservatively beyond that in terms of assumptions there? Then
my final question is just on head count and looking at the pipeline
that you've got, given the market conditions, do you anticipate your
operating expenses or head count having to rise more dramatically
than you may have thought?
DOMINIC FREDERICO: Okay. If I can remember them in the order that you
gave them. On the HELOC side, remember we only have about 2.5
billion, almost 1.7 is direct, so the rest is reinsurance. And that
reinsurance is spread over a host of transactions. 66 deals to be
exact. The largest being 90 million. We've got every one of those
listed, posted, stressed. We're concerned that there could be some
losses arising because a lot of them are written at the BBB level.
But individually if you looked at the mean, the mean exposure is
probably about $7 million in any one given deal. So once again use
the percentage methodology, even if we blow the expected outcome, 1
percentage point is $700,000 it is not going to be material, right?
TAMARA KRAVEC: Right.
DOMINIC FREDERICO: And we did no facultative in '06 where you would
see a larger size session coming to us. The treaty has a very limited
view of what can be ceded to us. In terms of the reserve, if you can
go back over that question again, on the reserve side.
TAMARA KRAVEC: Just wondering what your -- you had increased your
severity assumptions just based on S&P and I'm wondering if --
you commented that you use your own internal ratings. The rating
agencies are kind of a check, but are you -- was the discrepancy --
would you move beyond what the rating agencies are assuming just to
be overly conservative? In other words, I guess, would you feel like
you would have to review this again in a year and perhaps it could be
higher?
DOMINIC FREDERICO: Well, remember, that we're talking portfolio
reserves here, which is us being extremely prudent in how we assess
potential credit exposure across the entire book of business. Number
two, and I should have maybe highlight this, the critical element
that keys the portfolio reserve process is the rating of the
transaction because at different rating levels it kick up higher
levels of probability of default and severity. They are our rating
levels and about 30% of our book has a rating level lower than what
the published rating agency level is. So it is our conservative view
of the rating.
It then does cede the standard default and severity statistics that
get updated annually by S&P and we do that purely for
independence, purely for ease of audit and understandability and
transparency. Obviously that is only for the portfolio. Once we start
to look at the specific credit issue in any other content besides
portfolio, we start to apply our own reserving process. So the
portfolio, think of it as a book mark. It is a place holder to ensure
that we constantly look at our entire portfolio and understand the
ultimate potential expected exposure that it contains today based on
our rating and based on what we consider very reasonable estimates of
severity and frequency. Once we start talking true loss possibility,
that goes out the window, and it's all done with our own internal
view of losses. Right? Our underwriting standards use our severity,
so separate that from when we underwrite new business.
BOB MILLS: Head count.
DOMINIC FREDERICO: Head count.
BOB MILLS: I'll do that. From a head count standpoint we have grown
in the last year. At September 30, of '06, the head count was 131.
Today the head count is 144. We are expecting to continue to grow
head count into 2008. Naturally in this market there's probably some
subjectivity as to how and when that will grow, but considering the
opportunities that we see, we will continue to expand our head count
to meet those needs.
DOMINIC FREDERICO: We've obviously completed our 2008 plan, and in
the plan the head count addition is, I think--?
BOB MILLS: About 8%.
DOMINIC FREDERICO: 110 or 11 people in total.
BOB MILLS: 144 now to 156 in the plan.
DOMINIC FREDERICO: But that will depend on opportunity. Obviously I
think we've been trying to manage that very reasonably. We had to
build it before it came early on to make sure we could handle
business and assure execution. We now have been adding to the staff
as opportunity arise, and obviously based on the change in this
market you could see some significant opportunities develop that we
would then have to be responsive in terms of staffing up for.
Currently our plan is for a very reasonable moderate level of
increase.
TAMARA KRAVEC: Okay. Great. Thank you so much.
DOMINIC FREDERICO: You're welcome.
OPERATOR: Your next question comes from the line of Bob Ryan with
Merrill Lynch. Please proceed.
BOB RYAN, ANALYST, MERRILL LYNCH: Good morning.
DOMINIC FREDERICO: Hey, Rob, how are you doing.
BOB RYAN: My question is in your ancillary mortgage business, what
was the last time that you took on any new exposure there and what is
the nature of those exposures.
DOMINIC FREDERICO: Wow. They're -- the last time, all I can tell you
is the deals expire in three years. It was the last deals, they were
like 10-year deals. They're excess of loss, soft capital-type
programs written under the old -- old Company structure and business
plan. We did do a reinsurance deal in the UK in '04 and that was the
last deal that we've ever written. So they're high up. Principally
excess of loss. At one point in time we did get them rated, because
we felt that they were sort of like RMBS but a very high AAA type of
attachment. They're highly seasoned. So they're long outstanding
deals. So they don't suffer some of the current pang. We have got 1.4
billion of pars still out there and that continues to amortize down.
BOB RYAN: Great. Thank you.
DOMINIC FREDERICO: You're welcome.
OPERATOR: Your next question comes from the line of (INAUDIBLE).
Please proceed.
UNIDENTIFIED PARTICIPANT, ANALYST: Yes, good morning, hi Dominic and
Bob. I wanted to ask a couple of numbers questions and then bigger
picture on the reinsurance side. On the numbers side, when we think
about total capital resources, obviously qualified statutory capital,
present value of installment premiums, one element I didn't see and I
might have missed was the soft capital facilities. Could you just
remind us what if any you have in that regard and/or any other items
that we should be thinking about?
BOB MILLS: Sure, we have two soft capital facilities. One is a bank
soft capital facility which is at AGR in the $200 million, which was
put into place just recently in 2007, replacing an older facility.
And we have a capital markets facility of $200 million at AGC. That
was put on really as a term facility and that facility rolls over, is
up to be reissued in April of 2008.
UNIDENTIFIED PARTICIPANT: Bob, on that second one, is, in the event
you would need to tap it, for whatever reason, even if it's just to
give the agencies greater comfort, is that facility dependent on
availability and the opening of the asset-backed mark? Do you need to
rely on--?
BOB MILLS: No, it is a funded facility. It is not subject to auction.
But I must tell you, I cannot conceive of a circumstance where I
would have to draw upon that facility.
UNIDENTIFIED PARTICIPANT: Excellent. Thanks for clarifying it . And
maybe Dominic, on the reinsurance side of the business, I guess first
by way of disclosure, have you guys provided much granularity about
some of the other financial guarantors that you have exposure to? And
I guess given an environment where one would suggest that the terms
of trade would favor reinsurance. How do you think about growing that
on a go-forward
DOMINIC FREDERICO: In term of granularity exposure to the other model
lines, remember we underwrite every deal on the reinsurance side that
we see facultatively regardless of who is the primary writer, so it's
got to pass our underwriting standards. On the treaty side we only
have the one treaty. No, I guess we have two today, where we
specified parameters that in effect determine the type of business
that can be ceded to us. In both cases, if that is your question on
exposure of the other model lines, we're very comfortable with the
underwriting risk, and obviously it goes through the same process
that we use, when we underwrite on the primary side, as well.
UNIDENTIFIED PARTICIPANT: Dominic, just to clarify, you don't have
exposure below AA, AAA folks, do you? I guess the question--?
DOMINIC FREDERICO: As reinsurer, that cede to us, no. We only take
reinsurance from the existing AAA model lines.
UNIDENTIFIED PARTICIPANT: Excellent. Thanks. Then just finally, on
the environment for growth given your strong ratings and obviously
the demand pool?
DOMINIC FREDERICO: We're blessed on both sides. We see tremendous
market opportunity on both the reinsurance side and the direct
insurance side and there is a constant taffy pull in our Company
relative to capital and limit allocation between the two groups. As a
Company that does service the third-party ceding reinsurance
marketplace, meaning the other AAA model lines, if we're serious
about that business. We have to allocate capital to that business and
service that market. Obviously we see tremendous opportunity there.
We're well positioned by being head quartered in Bermuda with that
specific entity so that the, in effect economics that we get on a
reinsurance basis is good if not better than the primary Company
ceding to us. So there's no loss to what we'll call profitability
from that point of view. However, the direct business that we also
utilize through that reinsurance mechanism gets also further
enhanced, so there is a good argument on both sides of the fence. The
one thing we've always liked about having a foot in the reinsurance
door is it does spread our portfolio out, it does allow us to look at
basically every opportunity in the marketplace where we can be
further selective from an underwriting point of view.
UNIDENTIFIED PARTICIPANT: Thanks very much.
DOMINIC FREDERICO: You're welcome.
OPERATOR: (OPERATOR INSTRUCTIONS) And your next question comes from
the line of Adam Star. Please proceed.
DOMINIC FREDERICO: Hello?
OPERATOR: Mr. Adam Star, your line is open. .
SABRA PURTILL: You can go to the next question, operator.
OPERATOR: I show no further questions in the queue.
SABRA PURTILL: Thank you. Many thanks to you all for joining us
today. And we certainly appreciate your interest in Assured Guaranty.
As I mentioned, you can reach me in our Bermuda office today at,
441-278-6665 if you have any follow-up questions. I would also note
that a replay of this call will be available on our website as well
as by telephone at 888-286-8010 in the U.S., and at 617-801-6888 for
international callers. The password is 12378747. Please call me if
you have any additional questions and we look forward to talking to
you soon. Thank you and have a good day.
OPERATOR: This concludes the presentation, and you may all now
disconnect today.
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