Assured Guaranty Ltd. (AGO) Q3 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Assured Guaranty Limited Third Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Robert Tucker, Managing Director of Investor Relations. Please go ahead.

Thank you, Operator, and thank you all for joining Assured Guaranty for our 2016 third quarter financial results conference call. Today's presentation is made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The presentation may contain forward-looking statements about our new business and credit outlooks, market conditions, credit spreads, financial ratings, loss reserves, financial results, or other items that may affect our future results. These statements are subject to change due to new information or future events. Therefore, you should not place undue reliance on them as we do not undertake any obligation to publicly update or revise them, except as required by law. If you are listening to a replay of this call or if you're reading the transcript of the call; please note that our statements made today may have been updated since this call. Please refer to the Investor Information section of our website for our most recent presentations, SEC filings, most current financial filings, and for the Risk Factors. This presentation also includes references to non-GAAP financial measures. We present the GAAP financial measures most directly comparable to the non-GAAP financial measures referenced in this presentation along with a reconciliation between such GAAP and non-GAAP financial measures, in our current financial supplement and Equity Investor Presentation which are on our website at AssuredGuaranty.com. Turning to the presentation, our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd, and Rob Bailenson, our Chief Financial Officer. After their remarks, we will open the call to your questions. As the webcast is not enabled for Q&A, please dial in to the call if you'd like to ask a question. I will now turn the call over to Dominic.

Thank you, Robert, and welcome to everyone joining today's call. By continuing to execute on our strategic objectives, Assured Guaranty delivered excellent results in the third quarter of 2016. In addition to earning $508 million of operating income, we further positioned the company for long-term success through acquisitions and new business originations, while also enhancing returns to shareholders through share repurchases in our quarterly dividends. One of our key strategies has been to identify and acquire legacy financial guarantee companies whose insured portfolios are consistent with our risk profile. On July 1, we closed on our third acquisition, CIFG which added $293 million through operating shareholders equity and $512 million to adjusted book value at the acquisition date. At quarter end, adjusted book value was a record $66.34 per share, 8.4% higher than when the year began. The effects of our CIFG acquisition are reflected for the first time in this reporting period and Rob will give you details about the rest of our key financial results later on this call. In this near zero interest rate environment, which impacts new business opportunities, we continue to prioritize our acquisition strategy. We recently announced another important pending acquisition MBIA UK Insurance Limited, the European operating subsidiary of MBIA Insurance Corporation. By acquiring MBIA UK, we will add a season portfolio of almost exclusively European insured transactions that totaled approximately $13 billion of net par as of June 30, 2016, further increasing the geographic diversification of our insured portfolio. We expect this acquisition to be accretive to Assured Guaranty's earnings per share, operating shareholders equity, and adjusted book value. Additionally we believe this transaction provides a boost to our prospects in the European market by reinforcing the message that Assured Guaranty is committed to providing funding solutions for infrastructure finance in Europe. The MBIA UK acquisition is slated to close in January subject to the receipt of regulatory approvals and the satisfaction of other customary closing conditions. As we've noted before, our international diversification gives us a unique industry advantage in terms of both risk management and business opportunities. This is also true of our structured finance business which in the third quarter contributed $23 million of present value production or PVP. This was driven by a transaction where we provided excess of loss reinsurance on an insurance reserve financing. This transaction was generated, negotiated, and closed in Bermuda to AG REs specialty insurance subsidiary AGRO and it illustrates the flexibility that that unit provides us to offer innovative capital management solutions. Turning to U.S. Public Finance, we were very pleased with our performance in the quarter that saw the lowest municipal interest rates and some of the tightest credit spreads since our industry began. For the first time 30-year AAA municipal yield fell below 2% giving many issuers the most attractive yields they've ever seen. During the quarter we adhere to our strict underwriting process and disciplined pricing strategy. While this has caused us some market share, we nevertheless remain the market leader not only in insured parcel but also in a number of transactions that use bond insurance. Our third quarter 2016 primary market transactions represented $3.2 billion in new issue par which was 56% of all the insured par so during the quarter and 45% more than the par written by any other bond insurer. It is our view that market participants are differentiating among AA rated guarantors with some investors willing to pay more for the comfort of our large capital base, our guarantees broad acceptance by municipal bond investors, and the significantly higher relative market liquidity of our insured bonds. Additionally, we continue to see a positive response for Assured Guaranty's insurance on larger deals which typically have a strong institutional investor base. Year-to-date through September, we were selected to insure more than $100 million at par on 13 different transaction totaling approximately $1.9 billion of insured par, four of which sold in the third quarter. While we have the scale to make insuring large public finance transactions the key element in our business production strategy, small and medium-sized transactions represent the bulk of our business and we clearly continue to add value and provide great service for those transactions. Of the $10.1 billion of par of new issue sold with our insurance during the first nine months, $4.1 billion representing 554 of the 672 transactions we insured came from transaction of $25 million or less. Additionally our municipal secondary market business has been growing. This year through the third quarter we have insured $1 billion of secondary market par, 21% more than in all of last year and producing nearly 1.5 times our secondary market PVP of 2015. During the first three quarters of 2016, we increased U.S. Public Finance PVP by more than 12% over that of the nine months of 2015, while insuring 17% less par exposure and maintaining a comparable credit risk profile. Our financial results continue to significantly outperform those with the next most active bond insurer. While we are already one month into the fourth quarter, and many things can change, it's worth noting that October was the strongest month in U.S. Public Finance so far this year. During October, five additional transactions each selected Assured Guaranty to insure par of approximately $100 million or more for the new offerings. Company-wide we produced $129 million of PVP in the first nine months of the year, 25% more than in the same period last year. Now for an update on Puerto Rico. On the last call, I discussed the Commonwealth July 1 default on its general obligation and other debt. Subsequently on our August 31 appointments were announced to the Financial Oversight Board created by the PROMESA legislation. The board members represent a range of viewpoints but on the whole we think they have appropriate background and will take a reasonable and serious approach to reform and restructure on the island. It appears that the choice of an Executive Director will be the 1st of January. This coincides with the commencement of the new administration for the next elected Governor. We sincerely hope the next Governor will take a more responsible approach to solving the many changes facing Puerto Rico than the current Governor has taken. It also appears this will be a highly engaged Oversight Board especially while they operate without an Executive Director. The board has taken a number of actions since it's first met on September 30. They requested and obtained a fiscal plan from the current Puerto Rico administration as well as commitment to supply ongoing cash flow reporting. It asserts rights to approve financial transactions and debt exchanges by entities covered by PROMESA rejecting a transaction of one public corporation. It demanded additional fiscal plans from each of the six public corporations, including certain credits we insure namely the Electric Utility, PREPA, the Water and Sewer Authority, PRASA, and the Highway and Transportation Authority, HTA. Also the board is off to intervene in pending litigation. Regrettably the fiscal plan submitted to the Oversight Board by the outgoing Governor fails to address the root causes of the Island's current fiscal mismanagement. This regards creditors' rights and fails to provide a realistic roadmap to a economic recovery. With regard to the PREPA negotiations we continue to make progress. The restructuring agreement still needs good validation and rating agency ratings to go forward. Puerto Rico related bonds we insure continue to hold their value relative to comparable uninsured bonds. To give one example HTA bonds with our insurance have generally been trading at par or higher, while identical or nearly identical uninsured bonds have been trading around $0.27 in the dollar. This ability of our guarantee to help provide market value protection when an issuer develops real or perceived credit problems has been demonstrated in a variety of situations. And in a very important and variable benefit of Assured Guaranty bond insurance. In recent rating agency developments, Kroll Bond Rating Agency awarded a AA rating to Assured Guaranty Corp. on September 20. As a result, each of Assured Guaranty's U.S. financing guaranty subsidiaries now carry financial strength ratings of AA plus or AA flat with stable outlooks from two major rating agencies. On August 8, Moody's affirmed all of our current ratings on Assured Guaranty companies maintain the stable outlook for AGM's A2 rating and revised a stable from negative, the outlook for AGC's A3 rating. Moody said the ratings reflect Assured Guaranty's strong overall capital profile and core earnings power. Our ability to underwrite transactions with both public finance and structured finance markets worldwide, to our multiple insurance operating subsidiaries, and the ongoing improvement in our capital adequacy as well as our leadership position in the financing guarantee insurance sector. Specifically with regard to its improved outlook for AGC, Moody said AGC's strengthening capital adequacy profile noting that our recent acquisitions of Radian Asset Assurance and CIFG increased AGC's capital resources, invested assets, and future premium earnings. Looking ahead, I'm pleased to say that our board of directors has authorized the company to buyback an additional $250 million of common shares. Share repurchases are an important way we manage the excess capital we are generating as our legacy portfolio amortizes faster then we can add new business in the current environment. There are however practical and regulatory constraints as well as rating agency considerations that limit how much we can buyback in any given timeframe. Additionally, we hope to put some of this excess capital to work in ways we could generate higher return within our limited tolerance for risk. To this end, our new alternative investment group is conducting a disciplined search for acquisitions or business opportunities where there is a strategic and financial stead with our company. Of course such opportunities must not interfere with our central mission of providing strongest financial guarantee insurance available. I will now turn the call over to Rob.

Thank you, Dominic, and good morning to everyone on the call. This quarter we recorded operating income of $508 million. The CIFG acquisition generated approximately $308 million of operating income or $2.32 per share in third quarter and added an incremental $3.85 to adjusted book value per share, bringing adjusted book value to $66.34 per share. The primary components of the CIFG contribution to pretax operating income were $357 million bargain purchase gain representing the excess of the fair value of net assets acquired over the purchase price, offset by $98 million loss due to the settlement of pre-existing reinsurance agreements between CIFG and Assured primarily related to Puerto Rico exposures previously assumed by Assured from CIFG. The CIFG acquisition often increased statutory capital by $310 million and claims paying resources by $388 million, in addition to the CIFG acquisition, operating income benefit from significant refunding activity in the quarter due to the low interest rate environment. Operating net premiums earned and credit derivative revenues from refundings and termination were $130 million in the third quarter of 2016 compared to $105 million in the third quarter of 2015. Operating loss and loss adjustment expense in the third quarter of 2016 was the benefit of $17 million. Economic loss development was also a benefit of $44 million which includes a $29 million benefit caused by the increase in discount rates. The other primary drivers of the favorable development were improved performance in the U.S. RMBS portfolio and the benefit resulting from purchases of insured bonds to mitigate losses. This is our second part by reserve increases on certain Puerto Rico exposures. The effective tax rate on operating income in the third quarter of 2016 was 3.8% in the aggregate and 11.7% excluding the non-taxable bargain purchase gains. This compares with 24.1% in the third quarter of 2015. The decline in the effective tax rate compared with the third quarter of 2015 was also attributable to the portion of income in non-taxable jurisdictions. I will now address our holding company liquidity and capital management activities. As of October 31, we had $14 million in cash and investments at the Bermuda Holding Company and $128 million at the U.S. holding companies. With respect to share repurchases we bought back 2.1 million shares in the third quarter of 2016 for $55 million at an average price of $26.83 per share. Including the additional 20 million in shares that were repurchased since the end of the third quarter, cumulative share repurchases since we started our share repurchase program in January 2013 represents a 34% reduction in shares understanding as of November 3, 2016. These repurchases have contributed approximately $8.17 per share to operating shareholders equity and $13.85 to adjusted book value per share. As Dominic mentioned on November 2 our Board of Directors approved an incremental $250 million in share repurchases which brings our current remaining authorization to $345 million as of that date. I am very pleased with the quarter's results and the significant increase in value, we have been able to achieve with the successful execution of the company's key strategic initiative, in particular the CIFG acquisition and the continuation of our share repurchase program. I will now turn the call over to the operator to give you instructions for the Q&A period. Thank you.

We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Chas Tyson of KBW. Please go ahead.

I just want to ask on capital return. It seems on the 2Q call, you had indicated you wanted to get 2016 capital turn up to 2014 or 2015 levels, that seems like on this morning's call you are saying that there is some practical and regulatory constraints and rating agency considerations, can you help us where kind of prior comments was how you are thinking about the potential special at this point?

Sure. So we said Chas back in the second quarter that we'd like to maintain the same basic volume and amount of share repurchase that we've been able to achieve over the last couple of years and that was our intention to do that or is our intention. However we also said we needed the approval of a special dividend from our regulator and principally here it's the New York DFS. So we've applied for the special dividend and like anything else, we sit here and wait for the potential approval of that special dividend request. Once given then I think we would be once again active in the market at a higher level of volume and activity to continue to move along the same basic objective of being aggressive with the management of our capital.

And Chas this would be over a long period of time so on average, we're trying to get to that level.

Okay, yes. I mean can you just talk about how you think about sizing request may be can give the exact color but I mean is it the goal just to get one year's worth of capital turn back up to prior levels or is this kind of a longer-term request we will get multiple years up to that longer term level?

Well the capital management is the longer-term strategy. The dividend request is more strategic right and how you want to position yourself with the regulators especially as we think we'll get more color over the not only financial strength of Assured Guaranty as it improves as well as dealing with some of the you know existing credit concerns and specifically Puerto Rico. So time helps in this regard. Number two we said that we give you a very good estimate of what the available cash flows coming out of the operating company to provide the necessary amount of free cash to buy shares which in effect as you can well know requires that we get special dividends, approved every year to maintain that volume. So when you look at your special dividend request, you say okay how do I want to position it strategically because I really want to be able to make the regulators appreciate that this is an ongoing part of our strategic objectives and view and therefore get them into position where an annual approval doesn't take as long as the initial approval and becomes kind of an accepted practice within the company. So we want to maintain the volume. We need special dividend request. We are requesting a special dividend or have requested it. We would anticipate doing that annually to continue to provide the necessary funding; so that we can continue the capital management that we believe the company needs to exercise especially over say the next two to three years while we still see basically the interest rate environment that we're stuck in that specifically or significantly hampers new business opportunities.

Okay. That helps and then on one last one on PREPA. I know you said that before I go to rating agency and validation process obviously the PREPA has been designated as a covered instrumentality by the Oversight Board. I mean do you essentially see that as going through Title VI process under PROMESA at this point and that do you think that changed anything about the agreement that you have in place whether your side of it or the people who haven't signed on to the agreement?

No I think the current potential impact of PROMESA we believe is a positive relative to the PREPA restructuring or the PREPA negotiation and we consider that still going on course and we would believe that the PROMESA board would support the PREPA restructuring as currently constituted. And since it's already been not only accepted by us the majority of the creditors, the regulatory, the utility board, the government itself as well as the existing Governor, we believe that makes the most sense and therefore still got to go on this rather slow path where we expect it to be accomplished.

[Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Robert Tucker for any closing remarks.

Thank you, Operator. I would like to thank everyone for joining us on today's call. If you have additional questions please feel free to give us a call. Thank you very much.