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Q3 2007 Scottish Re Group Limited Earnings Conference Call - Final
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| Copyright: | CCBN, Inc. and FDCH e-Media, Inc. | | Source: | FD (FAIR DISCLOSURE) WIRE | | Wordcount: | 7107 |
OPERATOR: Good morning. My name is Rich and I will be your conference
operator today. At this time, I would like to welcome everyone to the
Scottish Re Group Limited third-quarter earnings conference call. All
lines have been placed on mute to prevent any background noise. After
the speakers' remarks, there will be a question-and-answer period.
(OPERATOR INSTRUCTIONS)
Thank you. It is now my pleasure to turn the floor over to your host,
George Zippel, President and CEO. Sir, you may begin your conference.
GEORGE ZIPPEL, PRESIDENT, CEO, SCOTTISH RE GROUP LIMITED: Thank you,
Rich. Good morning, everyone, and thanks for taking the time to join
us this morning. Before we begin today's presentation, let me remind
all listeners that certain statements included in today's
presentation are forward-looking statements within the meaning of
federal securities laws. Management cautions that forward-looking
statements are not guarantees. Actual results could differ materially
from those expressed or implied in the forward-looking statements.
And we expressly incorporate the risk factors contained in our
Company's SEC filings.
There will be a recording of this call available after 11:00 Eastern
time this morning, running through November 22nd. Instructions on how
to access the replay are included in your conference call invitation
with today's earnings release. Also, a replay of the call can be
accessed on our Website at www.scottishre.com.
Joining me today are Duncan Hayward, our interim Chief Accounting
Officer, and Terry Eleftherion, who will officially become our Chief
Financial Officer next Monday. Following our prepared remarks will
open the phone lines up for a Q&A session.
Now let's turn to the third quarter. My first few months with
Scottish Re have certainly been full of excitement and challenge. In
addition to learning the life reinsurance industry and seeing
firsthand how our Company operates, I've had the opportunity to dig
deeply into several issues and opportunities facing our Company.
I'm pleased that Terry has joined us as our new CFO. He's been
working in the Company in a transition role for just a few short
weeks, and he has already made a positive impact on our financial
processes and controls.
Duncan Hayward, who will be stepping down tomorrow as our interim
Chief Accounting Officer, has done an excellent job in that role over
the last two quarters. He's brought experience, discipline and
integrity to the assignment, and he's kept his sense of humor
throughout. Our International segment will be very pleased to have
Duncan back as their full-time CFO beginning next Monday.
As you can see from our results, the third quarter was what I will
call a tale of two Scottish Re's. On one hand, we delivered positive
pretax operating income, the first time in four quarters that we've
done that, which reflects the improving economics of our in-force
books of business. This quarter's pretax operating income also
exceeded our financial plan by a wide margin. We saw a 19% higher
pretax operating income in North America, improving margin
enhancement in International, despite a tough year-over-year
comparison, and lower corporate expenses. We're confident that the
operating fundamentals of the Company will continue to improve over
time.
On the other hand, we incurred $95 million of subprime realized
losses, some due to projections of future principal losses and some
due to changes in our ability to hold certain securities to maturity.
We also incurred almost $15 million of marked-to-mark losses on
certain funds withheld at interest ModCo treaties. Initially, our
subprime exposure resulted in a reduction in shareholders' equity
because unrealized losses on subprime assets increased by $300
million from June 30th.
We also had a number of positive developments in the quarter. In
September, we closed the Clearwater Re XXX financing transaction in a
difficult market environment. We made solid improvements to our risk,
financial and operating disciplines, and have good momentum in these
areas. We also made progress recruiting new leadership into the
Company. In addition to Terry, I expect to make several key executive
appointments in the coming weeks.
Despite the mixed results this quarter, I'm optimistic that we will
ultimately be successful in delivering on the full priorities I laid
out for you on last quarter's call -- namely, restoring Scottish Re
to profitability, delivering consistent operating performance, moving
our ratings towards and ultimately achieving the A category, and
creating long-term shareholder value.
Before I turn it over to Duncan, I want to make a few additional
comments on subprime. First, working with our third-party asset
managers and others with deep knowledge of the subprime market, we
performed extensive analysis on our subprime holdings during the
quarter. At this point in time we feel, we feel we have used a
reasonable set of assumptions around how the subprime market will
affect us over the coming months and years. Duncan will walk you
through those assumptions later in the call.
And while we're disappointed to have written down $54 million of book
value to reflect the current market values of bonds for which we
project future principal losses, we are confident that we've taken
the right action to reflect properly today the impact that subprime
will have on us over time.
We also took an additional $41 million of subprime impairments
through the income statement, not because we project future principal
losses, but because certain bonds held in securitization structures
have been downgraded by the rating agencies to a level that gives the
guarantors of those securitizations the right to force us to sell
those bonds, a right which they have currently waived so as not to
require us to sell money-good bonds in a bad market. This impairment
phenomenon affecting the income statement is one that may continue
should subprime bonds that we hold in the securitizations be
downgraded in the future.
As you began to see in our 8-K filing following last quarter's
earnings release, we are committed to complete transparency with
respect to our subprime exposure. In fact, you'll notice additional
subprime disclosures in the third quarter 10-Q that we intend to file
with the SEC tomorrow. Included in the Q will be quite a bit of
detail on the specific assumptions we used to determine which
subprime and Alt-A securities to impair during the quarter.
On a final note, we expect to file an amended 10-Q for the second
quarter later today. The 10-QA will reflect a calculation adjustment
to second-quarter earnings per share, an item which, as previously
reported, has no impact on our financial condition. As you may
recall, the EPS issue was raised as part of an SEC comment letter we
received in September. Since that time, we have worked with the SEC
to close out all matters to our mutual satisfaction.
I'd now like to turn the call over to Duncan, who will walk you
through the third-quarter financial results.
DUNCAN HAYWARD, INTERIM CAO, SCOTTISH RE GROUP LIMITED: Thank you,
George. Scottish Re reported a net loss attributable to ordinary
shareholders for the third quarter of $109.5 million or a $1.60 loss
per diluted ordinary share, as compared to a net loss of $30.5
million or $0.54 loss per diluted ordinary share for the prior
period. This loss was driven by $95 million in realized losses on our
$3 billion subprime and Alt-A bond holdings, and a $14.8 million
charge net of deferred acquisition costs in the value of embedded
derivatives related to certain funds withheld at interest.
On a consolidated basis, revenues for the third quarter were $500
million, down 18% from the prior year. If we exclude realized losses
on investments and the change in the value of embedded derivatives,
total revenues were essentially flat, with North America revenues
marginally up and International revenues slightly down
year-over-year, driven by the exit from the Middle East business,
which we announced earlier this year.
Earned premiums for the quarter were up 1% to $456 million when
compared with the prior year, with North America up 2% and
International down 13%, again driven by the exit from the Middle East
business.
We use operating income or loss as a basis for assessing our
operating performance at Scottish Re. We define operating income or
loss as the pretax income before realized gains and losses and the
net change in the value of embedded derivatives.
Operating income for the third quarter increased $1.6 million as
compared with $0.2 million for the prior year. This increase was
driven by a 19% increase in North America, partially offset by a
significant decrease in the International business, driven primarily
by a onetime annuity recapture in 2006, and also a lower operating
loss in our corporate segment. I will touch on the major drivers of
our earnings for the quarter a little later when I discuss the
results of each of our segments.
Unlike last quarter, our tax line was fairly benign. We recognized a
net tax benefit of $7.8 million, due principally to the ongoing tax
benefit from the redomestication of Orkney Re and a further release
of our valuation allowance for deferred tax assets.
I would now like to spend some time discussing the primary driver of
our net loss this quarter, a $95 million subprime/Alt-A impairment
charge. Subprime and Alt-A loan performance has deteriorated
significantly during the quarter, and the market is becoming
increasingly illiquid and unbalanced, causing market prices to
decrease such that the market value of many of our bonds has fallen
below their amortized cost.
As of September 30th, Scottish Re had subprime and Alt-A residential
mortgage loans with a book value of $3 billion, or 27% of our total
investment portfolio. Subprime bonds had a book value of $1.9
billion, which represents 17% of our investment portfolio, and Alt-A
bonds had a book value of $1.1 billion, which represents 10%. $2.3
billion or 77% of the total subprime and Alt-A bonds are owned by
three of our securitization vehicles -- Ballantyne Re, Orkney Re and
Orkney Re II. For the purpose of this discussion, I will talk about
the subprime and Alt-A bonds collectively as subprime assets.
Through October 31st, 65 of our 768 individual subprime securities
experienced rating downgrades. Even after several rounds of
downgrades, the overall credit ratings of our subprime assets are
generally high. 80% of the bonds are currently rated AA- or higher
and almost 98% are rated A-, A3 higher.
Let me move on to discuss our methodology and approach in calculating
our third quarter realized loss on (inaudible) prime assets. As part
of our third quarter impairment analysis, we conducted an extensive
review of each of our subprime bonds in accordance with generally
accepted accounting principles. We have written down any subprime
bonds where we estimate we will not recover the full amortized cost
or where we cannot prove our ability to hold the bonds through
recovery of amortized costs in accordance with FAS 115.
In summary, the impairment charge of $95 million to subprime can be
categorized into two (inaudible) categories. Firstly, $54 million
related to securities where we have a projected principal loss of
greater than 1%. Secondly, $41 million related to other than
temporary impairments as defined by FAS 115.
Let me describe in more detail now how we arrived at each of these
components of our subprime impairment charge. Firstly,
notwithstanding our intent and ability to hold our subprime bonds
through a forecasted recovery of fair value, we have conducted an
assessment of each bond below AAA to evaluate the likely realization
of amortized costs. Working with our third-party investment managers,
we performed detailed cash flow analyses on our subprime holdings,
using conservative best estimate scenarios, including general
assumptions for all bonds and deal-specific assumptions for each
individual bond.
These deal-specific assumptions included default curves that took
into account the underlying collateral, loan originator, vintage, and
[tranche] seniority. For all the bonds, we assumed prepayments on the
underlying collateral will be slower than originally modeled, or more
precisely, 75% of pricing speed.
For subprime bonds, we assumed the existing delinquency pipeline
experienced a severity of 50% over 18 months, and that new
delinquencies would experience a 40% severity after the first 18
months. For Alt-A bonds, we assumed the existing delinquency pipeline
experienced a severity of 25% over 18 months, and that new
delinquencies would experience a 20% severity after the first 18
months. We then ran multiple cash flow simulations for each of our
subprime bonds using these assumptions to estimate a projected
principal -- any projected principal losses, and our best estimate
calculated a projected $86 million of principal loss.
GAAP requires that we write down through the income statement the
difference between amortized cost to market value as at September
30th, 2007 on these bonds. And as such, $54 million has been realized
as a loss. GAAP does not allow us to book the projected principal
loss as an impairment, nor does it take into consideration the value
of interest payments received up to the time that principal is lost.
The second category of subprime impairments related to bonds which
did not display any principal losses in our cash flow simulations,
but where we are required to record an other than temporary
impairment under FAS 115. As I mentioned earlier, certain of the
bonds held within our securitization vehicles were recently
downgraded by one or more of Fitch, Moody's or Standard & Poor's.
The investment guidelines of certain trust accounts within our
securitizations require that should a bond be downgraded below A-,
then we must sell the -- bond and use the sale proceeds to purchase a
bond of a rating equal to or greater than the original rating of the
downgraded bond.
Although we don't presently intend to sell these bonds and the
financial guarantors of the securitizations are not requiring us to
sell these bonds, we can no longer demonstrate what is known in FAS
115 as an unfettered ability to hold them to realization of amortized
costs. Therefore, as required by FAS 115, we have written down
through the income statement the amortized cost of these bonds to
market value, recording a realized OTTI loss of $41 million for the
quarter.
As you know, we are required to mark to market through shareholders'
equity all bonds that pass the FAS 115 OTTI test and for which we
project no principal losses. During the quarter, we incurred
unrealized losses of $279 million on our investment portfolio. As of
September 30, 2007, accumulate unrealized losses net of tax and
deferred acquisition costs were $299 million.
Although realized and unrealized losses on the investments have been
significant in the quarter, the Company had total shareholders'
(technical difficulty) equity of $1.4 billion and available liquidity
of $468 million as of September 30, 2007. In addition, the total
invested assets within the Company's three securitization structures
exceeded the (inaudible) reserves by approximately $830 million.
I would now like to take a moment to review the most significant
factors impacting the operating income for the third quarter by
business segment. Our North American business, which we consider to
be our core business, had a strong quarter. Revenues were $464
million, down 19% from the prior year, but that was driven by the
realized loss and net embedded derivative adjustment mentioned
earlier. Excluding these items, revenues would have been flat against
prior year, and earned premiums were up 2% to $429 million.
Operating income was $19.5 million, up 19% from prior year and
significantly above our expectations. This was again driven by
favorable mortality on our traditional business and onetime positive
items, but partially offset by adverse lapse experience and higher
collateral financing costs attributable to our current ratings
environment.
The favorable mortality was driven by the ING block of business,
which was favorable for the third quarter in a row and contributed to
improved underwriting margins of about $6 million versus the prior
year. The favorable third quarter experienced in the ING and organic
Scottish Re blocks was partially offset by lower-than-planned
retrocession recoveries on the ERC block of business.
The adverse lapse experience I mentioned earlier related specifically
to our ING block of business, and results from emerging lapse
patterns which are different from those locked in through the
purchase GAAP reserve. What we are seeing happen is that some pockets
of business with lower margins are persisting at a higher rate. We
expect to see this dynamic ease as it is heavily driven by experience
on preferred term business in the first policy -- first several
policy years.
Moving to our International business, which we consider to be our
growth platform for the future. Revenues for the third quarter were
$30.9 million, down 18% from last year, and earned premiums were down
13%. These decreases were driven mainly by our exit from the Middle
East business. Excluding the impact of the Middle East, revenues
would have been done only 1% and earned premiums would be up 9%
year-over-year. Earned premiums from UK and Ireland protection
treaties increased by $11 million from the prior year.
International reporting an operating loss of $2.4 million compared to
an operating income of $6.5 million in the prior year. The decline in
income was driven by a favorable prior-year annuity recapture
amounting to $8 million, which was partially offset by higher
underwriting profit on the UK and Ireland protection business.
Our Corporate and Other segment reported an operating loss of $15.5
million for the third quarter, an improvement of 32% from the
prior-year loss of $22.7 million. The prior year included onetime
items for executive severance, professional fees, and other
expenditures incurred as part of the evaluation of the Company's
strategic options. The current period included lower financing costs
and a non-cash item related to the introduction of a new stock option
program of $7.6 million.
That concludes my prepared remarks regarding the significant factors
impacting the quarter. As we look forward to the fourth quarter, we
expect to report new business volumes at third-quarter levels. We
continue to explore opportunities to establish temporary credit
enhancement facilities, such as the one recently signed by the
International segment, but would only anticipate the benefits from
these in 2008.
We also expect that our expense levels will continue to improve over
prior quarters, with the absence of material onetime charges, such as
those related to the new 2007 stock option scheme, the change in
control costs incurred in earlier quarters, and lower restructuring
costs.
We currently expect our fourth quarter to generate an operating
result ranging from breakeven to a small loss. This tracks with our
expectation of continuing improved performance of our North America
segment, a reduced operating loss in our International segment and
stable Corporate expenses.
This concludes my prepared remarks. I would now like to hand over to
George to commence the Q&A session.
GEORGE ZIPPEL: Thank you, Duncan. Ridge, would you please open up the
call for Q&A?
OPERATOR: (OPERATOR INSTRUCTIONS) Richard Sbaschnig of Oppenheimer.
RICHARD SBASCHNIG, ANALYST, OPPENHEIMER: Good morning. Thanks for
taking the call. The question I just had, first of all, in terms of
the new management that you are expecting to add -- have contracts
been signed or have they officially agreed to join Scottish Re? It's
just kind of a matter of waiting until they can make an announcement?
GEORGE ZIPPEL: Richard, this is George. It's a good question. When I
joined the Company three months ago, there were four key open
executive positions -- the CFO for the Company, which Terry has
filled; both the CEO and the CFO of our North America segment, which
is our largest operating segment; and a new position for the Company
of Chief Risk Officer.
Where I stand with two individuals is I have verbal agreements from
both of them based on a term sheet, which was very specific, that we
provided to them. And their lawyers and our lawyers are now haggling
through the details of employment agreements. And at this point in
time we do not have them signed, but as I look at the issues in front
of us, I think it is just a matter of timing.
We are making good progress on the other position. Frankly, that
other position is the CFO of North American segment. And it was very
difficult to recruit somebody into that position without Terry having
been announced. And now that Terry is on board, he is making very
good progress with several very strong candidates for that position
as well. So, stay tuned.
RICHARD SBASCHNIG: Okay. that is helpful. The other question I had is
in terms of the new business production in North America, were any
treaties close to new business during the quarter?
GEORGE ZIPPEL: As you might imagine, the third quarter was a tough
position to be in for our North American and International sales
teams because of our disclosure of subprime and the EPS restatement
in the second quarter certainly didn't help the case.
That said, the North American team and the International team -- the
sales teams in particular -- continue to be extremely active out
there, bidding on new treaties, working on the value proposition to
clients, trying to demonstrate as much value that we can add to them.
Remember, a lot of the key customer-facing capabilities that we had
over a year ago when the Company got into its troubles still exist
today. They just have a tougher hill to deal with, given the subprime
issue in particular.
Specifically in the quarter in -- let me just cover International --
we did win a couple of treaties, one in the UK and one in Asia. In
North America, we did win one treaty. We had no treaty recaptures in
the quarter. And the one disappointment that we had is our largest
single client that represents the majority -- not the majority, but
the largest amount of our new business informed us that they decided
to close those treaties effective 1-1-08. Now, we're still fighting
and talking to try to get that decision reversed, but that was a
disappointment for us.
RICHARD SBASCHNIG: But still the new business additions are not bad.
One question I did have, on the subprime, in terms of the subprime
losses, I understand the -- just so I'm clear on the realized losses.
I mean, how much of that were actual cash losses versus kind of model
losses or other than temporary impairment type losses?
GEORGE ZIPPEL: Actually, none of the realized losses that we recorded
in the quarter for subprime were cash losses. Think about them in the
two buckets we described. One is based on the deep analysis that we
did and the simulation results that said we project in the future
principal losses; therefore, we have to impair those bonds. We have
not incurred any losses as of today.
RICHARD SBASCHNIG: Okay. The other question, in terms of the impact
on your statutory capital from both the realized and unrealized
losses, I mean -- I guess how much of that will translate through to
[SPAT]?
TERRY ELEFTHERION, INCOMING CFO, SCOTTISH RE GROUP LIMITED: As you
know, most of those subprime and Alt-A bonds are held within our
securitization structures. And the unrealized loss is obviously
flowing through the various trust accounts in there. As Duncan
mentioned earlier in his prepared remarks, there is about $830
million of additional excess assets within those trusts, and they are
not impacting the reserve credit trusts that would impact the
insurance subsidiaries.
GEORGE ZIPPEL: It should be noted that the securitizations themselves
are really driven by cash, the economics are driven by cash. The
accounting adjustments that we're making today as non-cash items do
not really affect the economics of those structures.
RICHARD SBASCHNIG: And then in terms of the -- I mean -- just so I --
and also understand the writedown. In terms of your experience
through October, it seems like the subprime environment for at least
some other financial institutions deteriorated in the month of
October. But do these adjustments take that into account as well? Or
do you anticipate -- just quarter to date, is there a substantial
change within the portfolio?
GEORGE ZIPPEL: Two comments on the impact of October. One is in the
current numbers that we've recorded for the third quarter, we have
reflected all of the rating agency downgrades of bonds that occurred
in the month of October, and we have impaired some and taken other
than temporary impairment adjustments for the others.
We have not reflected and are still working on the impact of the
lower subprime market prices that occurred in October. It is only a
week since the month of October closed, and our investment guys are
working with the managers to come up with the pricing. But suffice it
to say, directionally, market prices for subprime assets in the month
of October did decline. We are trying to calculate what was the exact
impact on us in the month.
RICHARD SBASCHNIG: Okay. And just one final question. In terms of the
unrealized losses, I understand your procedure for the realized
losses, but there has been some question over whether or not even the
pricing in terms of the unrealized losses. And I guess what is your
procedure there in figuring out what the mark-to-market is?
DUNCAN HAYWARD: Our prices are provided by external investment
accounting provided (inaudible). And they use the external sources
for prices, i.e. the marks that we made in the marketplace. And those
are fed through to us.
And there's a separate exercise -- we had some external work done by
our auditors to validate those prices against our own prices. And
they validated, I think, in excess of 90% of the prices. And that
gave us additional comfort that those marks that we've taken were
adequate for the purpose of putting the balance sheet together at the
end of September.
RICHARD SBASCHNIG: Okay, thank you very much.
OPERATOR: Jeff Bernstein of Schroder.
JEFF BERNSTEIN, ANALYST, SCHRODER: Good morning. In terms of your
credit rating plans, have you spoken to the agencies about this
quarter's results, updated it on your forward plans? And in addition
to all of that, what are your plans to get to the A?
GEORGE ZIPPEL: It is a good question. We have spoken very recently
with each of the four rating agencies that cover us about the
quarter. And I think their view is consistent with our
characterization, that they feel very, very good about the operating
performance; they feel very, very good about a lot of the initiatives
that we have in place to improve our risk in our financials and our
operational controls to drive more stability.
Frankly, I think they are thinking through the impact of the subprime
realized losses that we have just disclosed. I can't speak for them;
I don't know how they are going to evaluate that from a rating
standpoint. We certainly made a strong case that while it's a painful
but not surprising hit, it really doesn't materially impact the
capital position and the liquidity position of the Company.
In terms of our ratings plan going forward, we need to prove a couple
of things to them. One is we need to show that we can execute
consistently with fewer surprises than we've had in the past. And
clearly, the investments that we're making -- improving our
operational risks and putting a risk management framework in our
company, embedding it in the way we run the Company and the way we
make decisions -- is going to help over time.
The second thing that we have to demonstrate to them is that we have
ongoing franchise value in the marketplace. And given our ratings --
the ratings that we have, that is a tough proposition. But our
clients have been very loyal to us. We still add lot of value to
them. The pricing people and our clients that have done business with
our people continue to value us, continue to be loyal to us.
It's a tougher [putt] with them with their credit committees and
their risk committees, given our current rating. But we are going to
continue to work on adding value to clients, to win what treaties we
can win. We're looking at -- in our International business, for
example, we have already implemented a credit enhancement structure,
which gives our clients certain comfort for the time period between
now and the time that we expect to achieve our A rating. And in case
we don't get it, it costs us a little bit of money, but it's a good
investment for us to make.
And our assumption is we don't know when we're going to get the next
rating upgrade, but we have basically baked into our models that we
probably won't get back to the A- rating until calendar year 2009. I
think it is just a reality of where our ratings are today and what we
have to prove over time to get back to the A-.
But I believe -- I firmly believe that we are on a path to do that,
and we will make the investments and we will run the Company in such
a way that at some point in the future we will get that A- back.
JEFF BERNSTEIN: Well, as you say, the agencies are still thinking
through your subprime marks currently and, likely, prospectively. And
I think it's a fair bet that this topic as going to persist for some
time. It sounds like they're going to decide between keeping you
where you're at now or possibly going the other way. But as you say,
it's kind of a handicap to move forward without the ratings.
Let's shift to liquidity then; that is something they have been
concerned about. This Clearwater deal, does that take care of your
liquidity needs now?
DUNCAN HAYWARD: Yes, the Clearwater deal takes us through -- it's
actually -- with the current liquidity that we have available --
through to around 2009, based on our planned new business projections
that we have at the current time.
GEORGE ZIPPEL: Right. And another way to think about Clearwater is it
really didn't add any additional liquidity to the Company. What it
did was it replaced -- it basically financed our '05 and '06 XXX
business. It replaced a rather expensive and cumbersome structure
that we had in place. But that money -- the proceeds from that money
basically go into financing the reserves; they don't go into
liquidity used for other purposes in the Company.
And our liquidity is currently sitting at about -- I think it was 468
-- $458 million, kind of unchanged from three months ago. So we feel
pretty good about liquidity. And as Duncan said, as we project the
performance of our in-force books, as we project our level of new
business going forward, we think that current liquidity will get us
at least through 2009.
JEFF BERNSTEIN: Okay, thank you very much.
OPERATOR: Richard Sbaschnig of Oppenheimer.
RICHARD SBASCHNIG: Good morning. One question I had is do these
subprime losses affect in any way the indemnification agreements?
GEORGE ZIPPEL: The indemnification agreements --
RICHARD SBASCHNIG: With the new majority shareholders of the company.
GEORGE ZIPPEL: Not to my knowledge. And I'm seeing two other shaking
heads in the room.
RICHARD SBASCHNIG: Okay. Another question I had is if -- I'm just
wondering about kind of a hypothetical scenario. If subprime losses
were to dramatically spike -- let's say you've got -- you lose half
of your portfolio or something along those lines -- what would be the
options for the Company? Obviously, it mostly hits the securitization
vehicles. And I'm just wondering how -- what your options would be to
survive, essentially, at that point.
TERRY ELEFTHERION: Richard, this is Terry Eleftherion. It would only
become an issue for us to consider if these market value declines
become cash or economic losses, which would impact the surplus within
those trusts. And right now all those bonds are paying principal and
interest; we do not have the intent to sell those bonds. So that is
the only scenario in which it would become an issue.
RON BOBMAN, ANALYST, CAPITAL RETURNS: Yes, but this hypothetical
limit -- let's say you have a 50% economic cash loss or something on
the total portfolio. I mean, obviously, some of the XXX protection
might go away. Would you be able to work out a new -- do you think
you'd be able to work out a new XXX solution at that point, or would
runoff be the only option, or what would you think about doing at
that point?
TERRY ELEFTHERION: As I understand the structures, Richard, these
securitizations are bankruptcy remote. Worst-case scenario, we would
have to look at restructuring those securitizations and look at
options at that point in time. But we do not foresee that as of this
point in time.
RICHARD SBASCHNIG: Okay, all right. Thanks a lot.
OPERATOR: Rick Weber of Jefferies & Company.
RICK WEBER, ANALYST, JEFFERIES & COMPANY: Good morning. Just had a
couple of quick questions. The Stingray Trust, was that unfunded at
the end of the third quarter?
DUNCAN HAYWARD: We used about $50 million of its $325 million value
[as a facility].
RICK WEBER: Okay. Can you just go into a little bit more detail of
the loss of your largest customer, who indicated that they may close
the treaty 1-1-08? Can you just talk a little bit about what has
occurred with that and how you hope to get that business back?
GEORGE ZIPPEL: Well, the situation with that particular client was
that they, like other major insurance companies, have risk and/or
credit criteria that says that they can only do business with a
reinsurer who has a rating below a certain level for a certain period
of time. That particular client had continued to hang in there with
us and do business with us. We communicated very, very openly and
frequently with them, as we do with our other clients. And the
subprime disclosure this summer gave them an issue that they had to
deal with.
Frankly, the week before their credit committee was to meet to decide
whether to continue with us was the week that we announced our
second-quarter earnings per share restatement. Even though it had no
financial impact whatsoever, it was a piece of bad news that made it
very difficult for that credit committee. And I'm describing this
thing second or third hand, as my teams describe to me, such that
they, as much as they wanted to, they couldn't continue to do
business with us.
We are still on very good terms with them. We have very good
relationships with them. We have a lot of in-force business with
them, so that relationship will continue. They just made the tough
call for their company to close the open treaties beginning 1-1-08.
To the extent we show progress and momentum with Scottish, as we
expect, they have indicated a willingness to reconsider that
decision.
RICK WEBER: Okay. I guess, Terry, you mentioned the cushion that
exists in the securitizations was about $830 million, where the asset
values exceed the regulatory reserves required?
TERRY ELEFTHERION: That is correct.
RICK WEBER: And that number is down from the second quarter. Is that
a result of marking down the value of the assets?
TERRY ELEFTHERION: But also the increase in the reserves themselves.
RICK WEBER: As a result of the increase in the XXX.
TERRY ELEFTHERION: Yes. That is correct. As you know, the XXX
reserves grow over time.
RICK WEBER: Yes, they do. Okay, thank you very much.
OPERATOR: Richard Sbaschnig of Oppenheimer.
RICHARD SBASCHNIG: Just one final question. In terms of these credit
enhancement structures that you are working on internationally, I
wonder if you could just describe those, please.
DUNCAN HAYWARD: Effectively what it is -- and without going into the
full details in terms -- in a certain scenario, we can, in
conjunction with our existing cost clients or future clients, revert
the business through the [wrap] policy, and then retrocede it back to
ourselves. So in effect, what we are doing is passing the business
through another party, and then we get the business back, providing
our rating is above a certain level.
RICHARD SBASCHNIG: Okay, thanks.
OPERATOR: (OPERATOR INSTRUCTIONS) Jeff Kirt of Oak Hill Advisors.
JEFF KIRT, ANALYST, OAK HILL ADVISORS: Hi. I'm just wondering if you
could give a little bit more color on the $86 million of projected
principal loss for which you took the $54 million write-down. Just
trying to get a gauge for the amount of write-down in terms of par
amount. In other words, was it $540 million of principal amount that
was written down $0.10, or was it $54 million that was written down
[$1.00]?
TERRY ELEFTHERION: It was $54 million on the amortized cost that we
held at the time.
JEFF KIRT: So you took -- just to be clear -- in aggregate, those
bonds had $54 million of aggregate principal amount and you wrote
each bond down from whatever your cost was all the way down to zero?
DUNCAN HAYWARD: No, no. The basis of that number 54 is -- what you do
is you take the difference between the market value and your
amortized cost at the end of September, and it is that value that you
mark down. So you bring a down to the market value at the price it is
at the end of September. So you use the principal loss exercise to
identify which bonds you need to mark down.
JEFF KIRT: Okay, maybe if I ask it a different way. So the principal
loss related to those bonds projected was $86 million -- is that
correct?
DUNCAN HAYWARD: Correct.
JEFF KIRT: That $86 million was -- for the average bond, what percent
of par was that 86 million? Was it $0.10, $0.20, $0.50?
DUNCAN HAYWARD: We don't have that information, I'm sorry.
JEFF KIRT: Is it fair to say that those -- I would expect -- and
maybe I'm wrong -- that those $86 million of losses related to the --
I guess the 20% that is not triple A- or higher?
DUNCAN HAYWARD: Correct.
JEFF KIRT: Is that fair?
TERRY ELEFTHERION: Correct.
JEFF KIRT: Okay. And then can you just give a little bit more color
in terms of these subprime and Alt-A bonds, the mix of -- are they
comprised of -- I assume they are comprised of RMBS and bonds issued
by CDOs and maybe even CDO squareds. Is that fair? Or are they all
RMBS bonds?
TERRY ELEFTHERION: I just want to make one statement and reiterate
what George said a little bit earlier on. We are making a very, very
comprehensive disclosure around our subprime and Alt-A bonds in the
10-Q which will be filed tomorrow. In that document, you will find
information as it relates to amortized cost market values, unrealized
loss and realized loss for these bonds by [ratings], splits between
our securitization vehicles and non-securitization vehicles. We also
have discussed the impairment methodology and approach in great
detail, and we also provide details about capital resources and
liquidity that supports the securitization structures.
Our view has been at the Company -- and George and I are committed to
this going forward -- which is that we make complete and full
disclosure around this position. We've decided to lead rather than
follow, so I think you'll have all your questions answered when you
take a look at the 10-Q tomorrow.
JEFF KIRT: Okay. Okay. I'll look forward to seeing it.
OPERATOR: Thank you. There are no further questions at this time. I
will now turn the floor back over to your host, George Zippel, for
any closing remarks.
GEORGE ZIPPEL: Well, once again, we appreciate you taking the time to
listen to our view of the quarter, and we appreciate the questions
and we look forward to updating you next quarter on our progress for
the fourth quarter. Thank you very much.
OPERATOR: Thank you. This concludes today's Scottish Re Group Limited
third-quarter earnings conference call. You may now disconnect.
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