Assured Guaranty Ltd. (AGO) Q4 2016 Earnings Report, Transcript and Summary

Good day and welcome to the Assured Guaranty Limited Fourth 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, Senior Managing Director Investor Relations and Corporate Communications. Please go ahead.

Thank you, operator, and thank you all for joining Assured Guaranty for our 2016 fourth quarter and year-end 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 and 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 into 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. 2016 was a very successful year as Assured Guaranty continued to build on the solid foundation of our financial strength, strategic flexibility, disciplined risk management, and robust business model to remain the proven leader of financial guaranty insurance. The list of our 2016 accomplishments include $895 million in operating income, $185 million more than the previous record set in 2015, 40% year-over-year growth in annual operating income per share to $6.68, year-end operating shareholders’ equity per share of $49.89 a new high and 16% higher than the year earlier, a record year in adjusted book value per share of $66.46. The return to shareholders of $375 million of excess capital through $69 million in dividends and the repurchases of 10.7 million common shares, an 8% increase in our quarterly dividend to $0.13 per common share and in February 2017 a further increase of 9.6% to 14.25 cents per share per quarter. $214 million of present value of business production or PVP the highest annual amount in five years, continued leadership in the U.S. municipal bond insurance market providing insurance for more par issued than the rest of the industry combined and more transactions than any other insurer. Important progress in our strategy of acquiring legacy bond portfolios with the acquisition of CIFG NA in July and the September announcement that we would require MBIA UK which we accomplished in January of 2017. Removal of all debt from the balance sheet of MAC by completing its full repayment of the $400 million in surplus notes that AGM and AGC had provided for MAC's initial capitalization. In contrast, the next month's active bond insurer has been unable to pay even the interest on its surplus notes while continuing to produce statutory losses even without accounting for the surplus note interest charge. The establishment of an alternative investment strategies group to develop profitable ways to deploy our excess capital retained in our operating units and the equity markets responded to these achievements by raising the price of our common share of AGO at year end to $37.77 resulting in a 46% annual total return that significantly outstripped the 12% return of the S&P 500 index and the 23% return of the S&P 500 financials index. And it is further noteworthy that this stock appreciation did not stop at year end. Earlier this quarter our price per share surpassed $40 per share for the first time in our history. We have built our success by solidly executing strategies designed for the prevailing business and economic conditions. In the recent years this has meant dealing with the constraining effect of low interest rates on the new business activity of our Financial Guaranty subsidiaries. As a result in addition to being the only monoline to maintain an active presence in all three of our core financial guaranty markets, U.S. Public Finance, International Infrastructure Finance and Structured Finance we are focused strategically on managing capital efficiently, executing acquisitions and commutations, and mitigating losses. These alternative strategies have helped us to increase both shareholder value and the company's financial strength for the long term. In terms of new business production in 2016 total PVP was up 20% from the prior year with significant contributions from each of our core businesses. In U.S. Public Finance we saw low rates throughout the year with a 30-year AAA municipal bonds descending for the first time below 2%. The low interest rates have the effect of increasing refunding and overall municipal issuance in the United States, but also limited the penetration rates of municipal bond insurance. While penetration declined the total insured volume actually increased slightly during the year. In this environment as we normally do, we carefully focused on opportunities that would generate the most attractive long-term returns on the capital we committed. We consciously gave up some market share and insured volume by sticking to that discipline. But we were still selected to insure more product volume and more transactions than any other municipal bond insurer. We guaranteed 904 new issues sold with our insurance for total par insured of $14.2 billion, $3 billion more than the rest of the industry combined and 40% within the next most active bond insurer. We also increased the par volume of our secondary market business by 91% and in total we guaranteed over $16 billion of U.S. municipal bonds in 2016. While the total par volume of transactions we closed was 2% less than in 2015, our commitment to pricing discipline and the markets recognition of the value we add were reflected in the 30% increase in U.S. Public Finance PVP which reached $161 million. We have an important competitive advantage in our ability to insure significant portions or all of very large municipal transactions. In the primary market we guaranteed 18 U.S. Public Finance transactions. We provided $100 million or more of bond insurance for a total of $2.8 billion. These were among 57 transactions issued with $50 million or more of our insurance. One of the most important of our large transactions was the landmark Public Private Partnership, P3 transaction to help finance redevelopment of New York's LaGuardia Airport in which we guaranteed 412 million of par in the primary market and more than $180 million in the secondary market. With general agreement across the political spectrum in favor of significant infrastructure development, the P3 model is attracting a great deal of interest in public policy circles. P3 transactions have been executed frequently in the United States, but we have been engaged for decades in such transactions in the United Kingdom and Europe. We are uniquely qualified to provide credit enhancement for financings of P3 projects because we have the resources and experience as well as business relationships with the major infrastructure project developers. We can assist in transaction development and provide the underwriting diligence and long-term surveillance that can attract capital market investors to this type of project finance. Assured Guaranty is the only active guarantor with the balance sheet strength, underwriting capabilities and trading values to insure on a regular basis large transactions that are brought predominantly by institutional investors. But the bulk of our public finance business still comes from our strong market presence among medium-sized and small transactions. These are transactions where our market leadership and brand recognition as well as our bonds market liquidity and multiple rating agencies' financial strength ratings should be important to retail investors and their financial advisors. For all these reasons the market places a high value on our guarantee. This is evident in the $1.6 billion on par we insured on AA quality issues including 38 primary market issues totaling $1.1 billion. In public finance outside the United States we guaranteed infrastructure or regulated utility transactions in each quarter of 2016 indicating a more consistent deal flow than in previous years and booked $27 million in PVP. We further strengthened our commitment to international infrastructure finance through our acquisition of MBIA UK. The $12 billion of net par European infrastructure transactions it is added to our insured portfolio and will be reflected in our first quarter 2017 results. Under its new name, Assured Guaranty London Limited it will operate as a standalone subsidiary of AGC for the time being. We are actively working to combine all of our European insurance companies, but doing so is subject to regulatory and court approvals. Similarly, many of our best structured finance opportunities in 2016 were those where we work with institutional clients to devise one-of-a-kind solutions for specific concerns relating to capital management, credit or liquidity. In one case through our Bermuda based Specialty Insurance Company, AGRO we provide reinsurance for the [indiscernible] life insurance excess reserve financing. An example in the asset-backed market was an aircraft ABS transaction in which we guarantee the issuer's obligations to repay advances under a bank liquidity facility. Also in asset finance we actively pursued opportunities in the aviation space, one of which was executed by AGRO during the first quarter of 2017. Additionally, in the fourth quarter of 2016 we provided our first blue note [ph] guarantee for a commercial tenant. In total structured finance business closed in 2016 produced $28 million of PVP. We are pleased with the quality and volume of our business and given the interest rate conditions we have not generated enough new business in recent years to fully offset the natural amortization of our insured portfolio. That means we continue to generate excess capital which we last estimated to be $2.6 billion above the AAA requirement under the S&P Capital Adequacy model at December 31, 2015, a number that we are confident will increase to when it is calculated for the year of 2016 even when considering our $306 million in share repurchases during the year. Our excess capital demands a vigorous capital management strategy. At the beginning of 2013 we repurchased approximately 72.2 million common shares or roughly 37% of our shares outstanding which has made each dollar of revenue we generate significantly more valuable to our shareholders. On a per share basis, many of the measures our management and board consider most important in assessing company performance have improved including operating earnings, operating shareholders equity and adjusted book value. In November our Board of Directors authorized a $250 million increment to our existing share repurchase authorization. This week our Board approved an additional $300 million of share repurchases which brings the current authorization to $407 million. The pace of buybacks is governed by the paramount importance of protecting policyholders and our financial strength ratings and by statutory limits on regular and special dividends for distributions that apply to our insurance subsidiaries. In order to release more excess capital or insurance company capital, we obtained regulatory approval for a stock redemption plan that AGM executed in the fourth quarter which upstreamed $300 million of holding company level. This was a prudent stock redemption. Even after releasing that AGM capital and also paying $184 million in net claims in 2016 to protect holders of defaulting Puerto Rico related bonds, our group's statutory capital increased $231 million during the year and our insured leverage ratio declined. For example the ratio of statutory net par outstanding to total claims payment resources declined from 27 to 1 at year-end 2015 to 22 to 1 at year-end 2016. AGM, MAC and AGC, each have insured leverage ratios well below those of our next most active competitor. One reason our statutory capital grew is that we continued to execute our acquisition strategy. By acquiring CIFG NA we added approximately $310 million to our statutory capital. We also added $4.2 billion of net insurance exposure with the related unearned premiums. In addition to new business production, capital management and acquisitions our core strategy is loss mitigation. In 2016 this strategy focused largely on our various Puerto Rico exposures. A number of these issues have already defaulted and we have fully protected our insurance bond holders by making a total of $226 million in claim payments to date. During the year we and other creditors have commenced lawsuits to remedy violations by the Puerto Rican Government of its constitutional, statutory and contractual obligations to creditors. We know that to achieve the best overall outcome we must not only stand up for our rights, but also make a constructive contribution to resolving Puerto Rico's financial crisis and revitalizing its economy. We played an active role in the process that led to the US Government's Puerto Rico Oversight, Management, and Economic Stability Act known as PROMESA which was signed into law in June 2016. PROMESA establishes an Oversight Board to supervise Puerto Rico's financial affairs and debt negotiations and it has created an orderly and clear track for both consensual and nonconsensual restructuring. Critically, PROMESA requires respect for existing constitutional and statutory priorities and liens which is essential to maintain the rule of law and preserve the contractual rights of creditors and other stakeholders. We believe the board members have appropriate qualifications for a challenging job and we have met with a number of them. In pursuit of a consensual resolution that are fair and support the economic, the island's economic recovery, we also met with a number of creditors and stakeholders and with the new administration of Governor Rossello, who took office in January 2017. Unlike his predecessor, the new governor has indicated he is realistic about Puerto Rico's need for future market access and therefore its need to embrace a more consensual approach with creditors. In a positive side, the new governor recently decided to make an interest payment on constitutionally protected general obligations of the Commonwealth using money called back from certain other obligations. While we still believe that callback to be legal, the use of these funds to pay GOs as least applied to clock back was only purpose the law allows. It indicates a measure of respect to the legal priorities of various classes of Puerto Rico's debt as PROMESA requires. However, we understand that he may also reevaluate the Restructuring Support Agreement that we, other bond insurers, certain bondholders and the Puerto Rico Electric Power Authority renegotiated for more than two years. We and others have provided forbearance and liquidity that will allow PREPA to proceed past numerous legislative regulatory and judiciary hurdles. We understand the Governor's desire to review the RSA and welcome his input. So the PREPA transaction as currently configured provides substantial debt service savings compared with the status quo that permits PREPA to reassess the capital markets to refinance its current debt and to invest in needed capital expenditures. In addition to keeping investors haul through multiple Puerto Rico defaults our guarantee has done an outstanding job of supporting the market value of our insured Puerto Rico bonds. For example, as of December 31, 2016 certain AGM insured PREPA bonds were trading near par which is a price almost $40 higher per $100 of exposure than for uninsured PREPA bonds with the same coupon and maturity. We have a history of working through difficult situations like Puerto Rico to reach outcomes that are better for us than was widely assumed at the outset of negotiations. As S&P, Moody's and KBRA each have concluded we have the resources to manage potential losses under even severely stressed Puerto Rico scenarios and retain our current ratings. Our approximately $400 million of annual investment income alone is higher than the average annual net debt service for the next 10 years on all of our Puerto Rico exposures. In the end only true economic development will be the answer for Puerto Rico. We support the efforts of the Congressional task force on economic growth in Puerto Rico who's recent report contains many recommendations including for example some related to making federal support of the healthcare system more applicable to that of the states and changes in the tax policies such as extension of the earned income tax credit to Puerto Rico. By executing our four core strategies well we have increased shareholder value while maintaining a very strong financial position. All of our U.S. insurance companies' current ratings were firm with stable outlook in the second half of 2016. We periodically assess the value of each rating assigned to each of our companies and may request that our rating agency add or drop the given company's ratings. In September KBRA initiated its coverage of AGC by signing it AA rating, giving AGC AA stable ratings from both KBRA and S&P. With these two ratings we no longer believe that Moody's rating has value for AGC. We have asked Moody's to withdraw it. Before we did so, in January 2017 we arranged for S&P to assign AGC's AA stable rating through publicly traded AGC insured bonds that did not already have a public S&P insured rating and had either an underlying public Moody's rating below AA or no public underlying Moody's rating. Looking ahead we are confident that our strength and resilience will see us through whatever conditions develop. The Federal Reserve Board and stability and probably increase in interest rates and higher rates of historically increased demand for bond insurance, allow for better pricing and enlarge the number of opportunities we found economically viable. However, even if the Central Bank raises short-term rates it could take some time for the effect to reach the long-term debt markets where we operate. And insurers may bring fewer transactions to the market. We will constantly review our strategic priorities with the twin goals of improving shareholder and most importantly maintaining long term financial strength to protect our policyholders. I will now turn the call over to Rob.

Thank you, Dominic and good morning to everyone on the call. Before I review this quarter’s results I would like to draw your attention to a change we made to our calculation of non-GAAP measures. In 2016 the SEC issued updated compliance and disclosure interpretations for non-GAAP measures and how they may be presented to investors. After discussing these new interpretations with the SEC we agreed to include the effect of FG VIE consolidation in our non-GAAP measures. This change affects our reported operating income, operating ROE, non-GAAP operating shareholders equity and non-GAAP adjusted book value. Our release and financial supplement provides the effects of FG VIE consolidation that now included in each of these measures. All prior periods presented in the earnings release, investor presentations and those that I discussed today has been revised to reflect our new non-GAAP measures in a consistent comparative manner. As I noted this change was made in accordance with the SECs updated interpretations and not as result of any change in the terms of our economics of our contracts. FG VIEs relate principally to RMBS transactions and are typically concerned when certain triggers of met they give the company additional control rights. Despite the trigger event, the company’s obligation was and remains solely an obligation to pay only the shortfall on scheduled principle and interest when do. The new interpretations also resulted in a change to the presentation of the detailed line item reconciliations of net income to operating income. The earnings release and supplement now show only two products, one for operating income adjustments and the other for the effect of FG VIE consolidation. The first operating income adjustment column shows amounts reported in each line item and we subtract from GAAP amounts to arrive at operating income. The second column, we just tied over effect of FG VIE consolidation represents amounts included in operating income related to FG VIE consolidation had managements substracts from operating income to arrive at its internal core metrics. These core metrics are used to access financial performance and is the basis for our compensation measures. Let me give you an example so you can see how including the effect of FG VIE consolidation affects our non-GAAP measures. Operating income in the fourth quarter of 2016 was $139 million. Including a $16 million gains related to the effect of FG VIE consolidations. Under our previous calculation this FGBI gain would have been eliminated and therefore we would have reported our $123 million in operating income. We have revised the fourth quarter of 2015 operating income to $130 million which now includes a $13 million gain related to FGBI consolidation that has been eliminated to $117 million of operating income reported this time last year. The effect of including FG VIE consolidation gains in both periods was not a source of any material variance. The primary drivers of the increase in operating income on a quarter-to-date basis are lower lose expense on Puerto Rico exposures and higher net on premiums due to refunding and terminations offsetting product by lower credit derivative revenues. Economic loss development was a $102 million in the fourth quarter of 2016. $53 million of public finance loss development and $49 million of structure finance loss development. Our public finance development was primarily attributable to Puerto Rico while structured finance development was mainly due to a reduction in excess spread in first lien RMBS transactions. These amounts are net of $94 million benefit attributable to higher risk release due to discount losses. On a full year basis we had record operating income of $895 million in 2016, a 26% increase of our operating income of $710 million in 2015. Full year 2016 operating income of $895 million includes a benefit of $12 million for FG VIE consolidation which would have been eliminated under our previous calculations and would have resulted in operating income of $883 million. Full year 2015 operating income was $710 million which now includes $11 million gain related to FG VIE consolidation that was not included in the $699 million of operating income reported at this time last year. The increase in operating income was driven primarily by net earned premium accelerations due to higher refunding and terminations and lower losses on Puerto Rico exposures offset in part by lower credit derivative revenues as we actively terminated existing CDS and the in force book of business amortizes as transactions reach maturity. Operating income in both 2016 and 2015 included significant gains attributable to acquisitions. The full year effect of the CIFG acquisition in 2016 was approximately $320 million compared with approximately $318 million for the Radian acquisition in 2015. Total economic loss development in the full year of 2016 was $139 million [ph] which is net of a $15 benefit attributable to changes in discount rates. This was comprised of $269 million of public finance loss development primarily attributable to Puerto Rico exposures, offset in part by $130 million of positive development in the structure finance asset class resulting from loss mitigation strategies such as the acceleration of claims and bond repurchases. We have continued to execute on our share repurchase initiatives in 2016 as Dominic described. We received approval from the New York Department of Financial Services to return $300 million from AGM to its holding company which will allow us to expand the program in 2017. This week the Board of Directors authorized an additional $300 million in share repurchases bringing our current remaining authorization to $407 million. The Board also approved an increase in our quarterly dividends to $14.25 per share, $14.25 per share, $0.14 I'm sorry, $0.1425 per share excuse me, $14 would have been impressive. Shareholder dividends, share repurchases, recurring debt service and operating expenses at the holding companies are supported by the capacity of our insurance companies to return capital and pay dividends to the holding companies. Currently we have $29 million in cash and investments at the book Bermuda Holding Company and approximately $216 million at the U.S. Holding companies. During full years of steady execution of the share repurchase programs we have repurchased 35% of our outstanding shares for a total of $1.7 billion. The accretive value of this program is reflected in 41% higher operating income per share and 28% higher adjusted book value per share than would have been reported without these repurchases. In the first quarter of 2017, we will report on the MBIA UK acquisition which has been renamed Assured Guaranty London. We are still working on the fair value analysis of MBIA UK's book of business, but expect the acquisition to be accretive to our key metrics. I will now call – I will now turn the call over to the operator to give you the instructions for the Q&A period.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Geoffrey Dunn of Dowling & Partners. Please go ahead.

Thank you, good morning guys.

Good morning Geoff.

Dominic, can you talk a little bit about the new business environment? You went through a lot of details for the year, but I'm curious of what you saw from a pricing and demand standpoint in the fourth quarter. We have seen rates spike a little bit over the last, I think back in 2013 and 2015, but this is the first sustained move we have seen in a long time, how are clients reacting, how do spreads look and demand look over the last three, four, five months?

Well, as you can see from the results we reported Geoff, fourth quarter was a very strong production quarter, especially in the U.S. Public Finance markets. We are always hesitant to call a victory prematurely and until we see sustainable rate increases that are actually held across the board I'm still cautiously optimistic in terms of where we can get to relative to production. Our anticipation is we will see increased demand in the U.S. markets because two things are going on right, we still got continued argument on Puerto Rico which is kind of a threat against credit worthiness. You still have a lot of noise relative to Chicago, Illinois, New Jersey, Dallas, many areas around the country and we think that credit concern, credit perception will drive people to the insurance market. And as you said, there has been kind of although it has been moving all over the place, increase in rates where the 30-year MMD was over 3% at the end of the year and we think for this to be sustainable, we would love to see it north of 3.5 and then I think you are going to see more scheduled and reliable demand. But remember we are not just in the U.S. municipal finance market. As you see in the year we had basically new business written across all of our operations and we are very optimistic in terms of what we see in our European pipeline. As we said last year Europe grew business across every quarter in the year, we have got a very active and strong pipeline looking at 2017, so our expectation is we should be able to book better results in Europe as we have seen the corrected problems of the past kind of the reputation that we've had to rebuild, our guarantee is very competitive and across that P3 market. We think we do have the appropriate product to serve that ever increasing marketplace. And in structured finance we are creative. We continue to look at places to make our guarantee worthwhile and we are being helped by regulation both in Basel III and Solvency II and how they look at certain assets being held by financial institutions much like the life financing, life reinsurance financing that was strictly a Solvency II play. Now this is a great way to put capital to work within a very benign credit risk and still get paid reasonably for the opportunity. So we are not ready to call victory on U.S. Public Finance. We do see increasing opportunities on our two other core businesses and therefore optimistic about 2017.

Okay. And then Rob, can you - two things, can you quantify the par and PVP from muni-secondary activity in the quarter? And can you also remind how excess spread works in the RMBS deals and how do we have to think about your future provisions to the extent rates keep going up?

Well the first question par for secondary markets in the quarter was $807 million and we wrote PVP of $34 million for secondary markets and you have some primary as well.

We can back out of that, but the excess spreads?

So excess spread, the reason we had development in this quarter on excess spread is because on some of our first lien transactions, the assets of the transaction are fixed rate loans and the debt of those securities are LIBOR floating rate loans and LIBOR increased this quarter, but those fixed rate loans actually did not move. So that is going to affect your excess spread and we saw as we call spreads squeeze this quarter. If you look at what we have in total for excess spread in all of our transactions, it is approximately $225 million. So you could not get any larger than that. But that is if you lost all of that. Now that is also related to transactions where not all loans have been [moded] [ph] to fixed rate loans. So some of them have actually - the assets are actually also variable rate assets and variable rate loans. So I would tell you that I don’t expect to be significant in quarters to come, because I don’t think over time you could not have anything more than $220 million and so that is the entire amount, but I don’t expect it to be as significant as it was this quarter.

And does this quarter anticipate future rate increases to kind of front end load what the direction of rates look like?

We look that in our – in our scenarios we do look at that, so it is in our probability weighted scenarios.

Great, thank you.

The next question comes from Michael Temple, a Private Investor. Please go ahead.

Yes good morning. With regard to the figure that you cited that you had losses in Puerto Rico in 2016 of approximately $250 million, can you speak to the overall strategy going forward? Obviously as you stated you are going to assert your legal rights in court, but at the same time you're obviously working with the new administration to come to consensual solutions to move Puerto Rico forward. So how should we think of the reclamation if you will of some of those $250 million in terms of being rebooked in the form of claw back payments being made and/or repayments being made because of new negotiations on the remaining debt that you still insure which is net right now approximately $4.7 billion?

Okay, Mike I’ll take a crack at it. So you have to in our world accept it for what it is, separate the accounting from the economics. So under the rules of accounting for Financial Guaranty we are subject to a strict interpretation of how we must evaluate and book reserves. In the old days you would be able to put up a point estimate of what you thought was your most realistic view of what ultimately is going to happen. Today, however, you really have to determine all possible scenarios including from good to bad to ugly. And then probability weight those scenarios and that is the provision you have to put in your books and records as the reserves or the accounting hit that you would take in establishing a potential liability role to the outcome as to a default in any of your securities. That doesn’t necessarily coincide then with our negotiating position, our view of the credit the activity that we seek along with both the control board and the government. Obviously we feel very strongly about our contractual rights. We feel very strongly that PROMESA does recognize constitutional priorities and contractual liens which –we think is very positive and as you saw on the PREPA deal that was negotiated and although the Governor wants to take another look at it the bond insurance market was basically not having a recognizable loss but we were providing future value and a surety over the new bonds being issued that would allow them the ability to get sold to market and may be even have an investment grade rating. So, it’s a fluid situation. We fully expect to pursue all of our rights. As I said on other calls we are large enough creditor that although we can't force any deal we can definitely stop any deal, and it is our belief that we will pursue our legal remedies to the fullest extent possible and as I said we believe firmly in our contractual rights in constitutional priority that we expect to be somehow recognized and the yet it is a negotiation and obviously there is a lot of moving parts right now. So from an accounting point of view we have to consider all those moving parts. We have to formulate them in the scenarios, we have to probability weigh them and if you look in the current quarter, what has happened, well you have the government miss another payments. You've had a relook at PREPA. You had a continuing negative dialogue between the existing incumbent or the new government and the Control Board as to austerity measures and those things have to be considered when we look at our scenarios and probability weighting. So, there is a reserve we’re required to put it up, we have all sorts of rules and regulations that are promulgated that we must follow and yet we have a strategy and negotiation and position that we’re going to take as a large creditor in this marketplace. I'm not saying never the two shall meet, but obviously the two are going to set off in very different directions and whether they ever come back and meet each, who knows, but we have to make sure that we're responsible relative to the rules and we also maintain our position relative to the protection of bondholders.

Okay, can I ask one quick follow up?

Sure, you pay for it though.

I more than appreciate the dynamism. It’s a fluid situation. Is it fair to say that Kroll and S&P and the others who are evaluating your credit worthiness have more than taken into consideration the developments or should we be prepared that perhaps in 2017 we might see them reassess negatively some of the stress scenarios for your exposure, again given the fact that things are still very highly fluid and we've seen some rather indicative outlook again or it is all part of negotiations rather negative outlook for what that service at the island might look like in 2019 et cetera, et cetera, so might we have to consider that further negative view points are adopted by the rating agencies regarding PR [ph] exposure at this time?

Well, Michael it is hard pressed for me to have to speak on behalf of the rating agencies because you wouldn’t be very kind or considerate, but be that as it may really that may be focuses on one of the rating agencies. But if you go back and look at their analysis they did and they each published and I would really call your attention to those, if you look those what they said was we looked at insurance financial strength, excess capital. We also looked at insurance internal rating and therefore their own analysis of potential liability. And under extremely stressed scenarios we find those circumstances which would A) change their view of the issuer rating or but honestly represent a major economic issue for Assured Guaranty. And they did contrast us against some of the other bond insurers. So they’ve already taken Puerto Rico and they believe and it has to work, but I think in some cases they are in the like 50% of all of our Puerto Rico obligations. And therefore I can’t believe it can get worse and if you think about it their stress, that they’ve applied in their models they have made the conclusion of our adequacy of both capital reserves and financial strength was well in excess of the government's last call for the former governor who was no friend of the bond market. So, I believe that and like I said I will call your attention back to their specific publications, but I don’t see that as an issue at all for Assured Guaranty in 2017 or beyond.

Alright, thank you very much for your time and explanation.

You’re welcome.

[Operator Instructions] The next question comes from Chas Tyson of KBW. Please go ahead.

Thanks, buenos diás gentlemen.

Good morning.

First question I wanted to ask is on just follow up on some of the Puerto Rico questions, so the governor last couple of days has been saying that he thinks the $800 million to $1.3 billion of debt service, probably if I look at the Oversight Board which put out of 2019 scenario which was fairly Draconian or how do you guys think about squaring those two data points with where your reserve is at spread a decent bit lower than the implied haircuts in the two statements made by those two entities?

Well I think there is a very strong argument that is going to have to play out relative to the amount of austerity that the government is willing to recognize or will be forced to recognize between what the Control Board is saying and the government. The real argument I think is going to come down to what is essential services because if you're really excited you are going to pay attention to contractual into constitutional priorities. The constitution is pretty clear that given the response it has to be for essential services, the governor made a first attempt of essential services which I know funding is going is going to be questioned significantly and therein lies what is the amount then for debt service. We had always anticipated in any sort of a work out that there will be some level of restructuring with some deferral of principal but the current payment of interest. If I can take any positive from what is going on the fact that the governor decided to pay interest up in February, general obligation also being to support part of the payments that we are doing in 2017 at least as an indication that point of direction. And as I said, once you argue down the percentage of essential services and make some collection improvements and some other things, will there be enough debt service available to pay the interest charge. I'm optimistic that potentially there will be and if not there will be this once again hard argument between the Governor and the Control Board. So one fact you have to take some comfort from is, remember one of the critical objectives of both the Control Board and the Government is to get access to the market and I don’t think it takes a genius to figure out that if you continue to fall upon payments and make no effort then continue to over expand or not consider as draconian are the measures that need to be applied in the country that is quite honestly manage itself and then situation on its own accord then you are never going to get better and especially don’t really getting out of control. Boy, things are going to get out a lot worse than better. So, if you really want to access we've seen to be one of the avenues of access part of EVS avenue. So the market I would that's access back the market I would assume that we’re treated with some level of respect. If I follow the language of [indiscernible], constitutional priorities and contractual links, I mean I have got to be close to the reasonable there and then will there be a deal done that may be changes that a bit, I don’t know. I think insured has positioned itself quite appropriately. We do carry reserves, we've have been fairly public. Every time we make or change the reserve to let the market down and for those of you who the keep score now you can probably try to figure out how much that number is and we’re comfortable that we’ve got the ability, the negotiating power, the seat at the table and has still protected the company as we go forward in Puerto Rico we’re in very good shape to handle whatever the, ultimate resolution here it becomes.

Okay and then following up on some of your comments, obviously there has been some media attention on the governors wanted to take a look at deal and some of the media articles have said that he wants to take specifically a look at asking the model lines to take a haircut which they want to required to under the current deal. I mean can you talk about is that kind of an off the table type scenario for you are you kind of willing to work with the new government and look at that deal again?

No, we work with anybody and understand we’ve never disclosed reserve positions and so we’ve let kind of be a mystery as whether we still carry reserves and not position regarding that we’re able to absorb some level of a discount. However, you've got to understand is that PREPA the government is relaying on substantially to provide Assured it is to get the new bonds issued and there could be position that we think that says if you make me pay at a loss I don’t provide Assured going forward. So what's more important to you, getting a small haircut from the buy shares and gained the ability to issue the new bonds. So these are the nearest of [indiscernible] table behind closed doors where voices typically get raised just to get pounded and decisions were ultimately made. But I think we’re in a very negotiating position Vis-à-vis the reliance on us to move forward and getting preferred debt to some level of market access because some level of reasonable rate relative to what the consumers and commercial accounts will pay. They still have to make a lot of operational changes relative to the correct metrics, the rate, stability, the securitization surcharge. A lot of things still have to be done, but I think we played critical role in that and then somewhat wants a pass the hat around the table. We will look at that in accordance with other things. But once again, if you are asking us to be an integral part of the solution to unfold, I am hard pressed for you to come back and then say but I want you to throw over the par as well. I don’t think we should doubled up in this regard.

Okay and then just separate topic, but on M&A obviously you guys have been pretty successful over the last 12 months on your consolidation strategy with CIFG and MBIA UK coming up, and it's obviously a couple other potential targets out there with I think all are pursuing strategic opportunities that the deal that you guys disclosed, the potential deal I should say which FIG can you give us an update on how you are thinking about consolidation of the space in 2017 and how many more you would like to see financial grantors you can still get?

And I think we keep saying that there is 4.5 to go and 3.5 to go I keep losing track and it's our goal to consolidate the more we think it is the best thing on behalf of the industry on behalf of bondholders and really provide stability where currently there is still this uncertainty. So I think it is a positive movement for the market in general. Number two, we think it is a positive movement for these companies. They are not trading. They’re basically sitting on a melting ice cube of value. But they've got huge NOLs, they need to be put to work if they are going to be put to work and it's not going to be based on the do it portfolio of financial guarantee. So, they need to figure out something to do when they grow up and its 2017. So you’re good, nine year after crises and eight years after the majority of the crises it's the time to get up and do something. I think we have a compelling approach and rationale that it says all parities, bondholders and the incoming companies and we’re very optimistic that will continue on that path. As you know we've got the FIG reinsurance close we're there. We hope that it gets further support and becomes more of the acceptable opportunity in the current year. Obviously we look to provide those type of solutions or acquisitions. I mean the right thing about us we can do it either way we want to do it, but we still believe it’s a valued and it is a value to the bondholders, it’s the valued to the income and company and in terms of its ability to now go forward outside of the regulatory regime, it is trapping the capital, melting their earnings, using up a lot of expenses that have no real value in terms of doing a future book of business and therefore we have asked them to move forward and start to utilize NOLs. So in the old days we would take kind of the crusade to them and I’m hoping in 2017 they start coming to us. They said okay, you are right, we need to move on, we need to get something on our books or operations and utilize the NOLs.

Okay and then related question on use of the capital obviously, I mean you guys noted the share prices increased materially over the last couple of months. How you think about using capital given your other alternatives of obviously I'm sure your purchases one lapping, but your new ventures M&A and how you’re rank ordering your options at this point?

We are including it, but share repurchases are still number one, it's still number two, it's still number three, it's still number four. The acquisitions are typically capital accretive the way we engineer themselves there actually helped the problem. We’re exacerbating the problems if anything how you want to look at it, so that's been good and the track record in those have been very public and seen the value that the add. The new ventures, I mean we’re building this slowly and we are very critical in our assessment of opportunities in that space. We kissed a lot of frogs, found very few princes. And therefore I don’t see us deploying anywhere near capital where there is influence whatsoever relative to the amount of capital management we still need to get done in this company number one. And number two, it depends on the execution whether these things will take the capital charge that you could assume. In other words we take a position in a GP of an investment fund, but some of the underlying investments are investments greater would qualify for capital then all you are taking is the capital as it which paid for the GP and the investment side doesn’t take a hit at all. And number two, we've got a lot of, what I’d call capital charge investments that are rolling off our books anyway and freeing up capital beyond just what the portfolio and amortization is providing. So, we are in very, very good shape and continue to increase our excess capital even in spite of all the hard work we have done to manage the capital down, so we will continued to manage the capital down and as I said its still priority 1, 2 and 3 and 4. And although the prices got closed it used to be that’s the good news, bad news, it's still very accretive for us to buy back stock.

Yes, and then last question is just you guys touched on it earlier, but obviously rates are up in the last few months and poised to go further team is like, so is there a good way to for us to think about how much penetration rate just on an industry basis of non-insurance can go up as rates raise and I guess what’s the appropriate benchmark to be looking as we think about that penetration rate going up.

The anticipation is as rates so does penetrations. The problem we have is because we are still in single digits and we are very much influenced by who is the issuer of the movement or the issuer in the quarter in terms of size, liquidity, current ratings, it's harder to be able to assess that expertly. However, we will say that every time the MMD goes over three, we seem to have a spike in opportunity or demand. However, it doesn’t stay with rate and then continues to bob up and down. And therefore, until we get sustainable rate increases that stick in the market and really do affect short term and long term yields its harder to declare that when they see instances of increased demand every time the rates bobs, sure we can. Obviously we would like to see it permanent. We'd like to see a definite move upward of interest rates and especially in the 10-year treasury to make it, give us that opportunity. The interesting thing we do have kind of why we see the jumps when we go up at three is because market has been able to borrow on such historic lows any movement even a 50 basis point movement, we think will cause certain municipal budgets to have some concern and therefore say, wait a minute I need to get back to more the historical low and therefore you think He has been in a case where you would normally see insurance, there might be an insurance request just to try to lever that rate down. And remember, the amount of the uninsured volume that has gone out over these last few years has created the market opportunity for our secondary market execution which as I said in my comments was up of 91% year-over-year. So, we’re not seeing in the primary market, we are seeing it in the secondary market and the combination of the two led us to that, very strong number of product last year. And as I said where trade increases at least scheduled and our account would be driving clear and victory on our rate increase schedule it never worked right? But they say there is going to be three this year. They follow up for those three. I would be optimistic that there will be a substantial increase in opportunity relative to the insurance marketplace.

Okay. Thank you, very much guys.

You're welcome.

And we have a follow up from Geoffrey Dunn of Dowling & Partners. Please go ahead.

Thanks. I got a few here, number one drop in your category of 1 BIG this quarter pretty substantial, can you give any color on that?

Well, let me pull my BIG out there Geoff. So it went from, no it went down $1 million in the quarter, but year-over-year it is down around, I'm sorry, $1 billion dollars and from $2 billion year-over-year and I'm trying to figure out who is the big boy in that regard? I have to buy [indiscernible] but anybody remember? You know typically amortization, yes terminations accounted for well $500 million of lease terminations Geoff. So we would have them targeted terminations. So the major project was terminations in residential mortgages and corporate obligations is the big boy. So we have had a strategy that was going out to look at opportunities to risk mitigation and one of the major transaction types was terminations. In this case if I remember it was a European financial institution where we were training favourites. So they asked to do certain things relative with [indiscernible] and waivers and we said fine, you've got to tear up these deals. And remember although we have them as below investment grade, that doesn’t necessarily mean we were going to recognize a reserve generally and actual incurred loss. But the way our ratings says, the more or just a few far below certain level of debt service coverage, that is one of the primary issues that would make you in non-investment grade. We categorized it that way. So these were probably issues where we weren’t kind of loss, but we expected an economic loss. Classified as below investment grade and working with the financial institution in Europe this is one of the transactions that in the negotiation I am giving them amendments and waivers we've tore up these transactions.

Okay. And then you touched on it, but I was hoping if you could give a little bit more of an update on your alternative investment initiatives?

Well as they say we've kissed a lot of frogs found very few princes or princesses as the case may be. But we did make our first investment and it was more on a passive basis, but with very high return expectations as we went through a lot of analysis and scrutiny. That was for $100 million which will be funded over a two-year period. So the impact is negligible, and remember we make $400 million of investment in core year. The second one we got it close or getting close to making an acquisition. Remember we look at the acquisition on three basis, right? It has got to be financially creative, it has got to build at least utilized our core competencies and then we've got to research fully accretive. And we think we are fairly far down the road. So stay tuned in terms of an announcement. And at this point in time we are saying to protect the organization and build a very strong foundation. We believe we should have a portfolio of these type of risks and kind of the diversification of fund to funds and therefore you are looking at numbers and that's $100 million to $250 million range in terms of investments as of this point in time that could change sort of lock us into it, but we are, I can say we made one, but it is more passive than active. We are looking at potentially putting out an awful our first real active operating type of situation and they are all in the same areas of kind of credit, credit, credit and it's credit we know very, very well.

Okay and when you say passive does that just mean $100 million of money out of AGC or AGM invested into a fund?

Yes, yes.

Okay and then when you say active is that an investment at the operating co level or an investment outside of the operating?

Yes.

It is more operating co level. It might also involve invested funds as well in LPVs [ph] but we want to get piece of the OpCo and the piece of the GP.

Okay. So the GP investment is being made outside of AGM and AGC?

We haven’t decided yet.

It could go either way.

Okay, all right. Thank you.

And we have a question from Michael Cohen of Opportunistic Research. Please go ahead.

Hi guys, thanks for taking my question. I just wanted to touch base and get your perspective?

I haven’t a taken it yet, so be careful.

Got you, it is rather what is your perspective on the Ballantyne [indiscernible] case which judge [indiscernible] issued her ruling on the motion for partial summary judgment which on paper reads like she denied, but as was communicated, she did sort of give it in favor of the plaintiffs and how do you guys are thinking about that case which is headed to trial on March 13?

There you know lot of vaccines you got my general counsel dancing in the corner, so he obviously runs our litigation in the company. We are very pleased with the Judge's decision. We have already felt a reasonably strong case. We don’t litigation lightly. We will bring cases for just bringing a case from sake of [indiscernible] and therefore we're pleased with the judges current ruling and we look forward to a trial beginning in March.

Great and then maybe at a highest level if you could offer all of sort of some sort of roadmap as to sort of how you think things are going to evolve in Puerto Rico over the next six, 12, 18 months in terms of the milestones that we are looking for obviously getting PREPA finally done would be a great first step, but how are you thinking about the rest of it?

It is an interesting question and this is more of my view. And trust me, I say an awful lot to the various parties in Puerto Rico as you will imagine. But for me the smartest thing they can do is solve all the public corporations because all the public corporations are solvable and that is PREPA, PROMESA and transportation. If you leave transportation alone, meaning given back its revenue, it is fine. PREPA and PROMESA, PREPA was restructuring and it makes it fine process is fine and you then clear the debts of about $19 billion of debt which is never a bad thing and it will be a great victory and it will really set those on their way develop work credibility to the marketplace maybe even get you access as we've talked about in PREPA we would get you access. So we think that is a smarter play, it is easy to do. And therefore maybe that is something they consider because you know you are ultimately have the fight of sites between GO and COFINA and I'm not going to tell you where my view is because that will get too much activity. But you are going to have that battle at some point in time, someone is going to blink and that is where really the main lifting that has to be done and therefore that makes sense. But there is going to be some compromise done in the market, it makes sense you get it all together and you knock it out once. Remember, you do have the one issue that they have to be cognizant of in terms of the delay of getting any of these deals executed and she got the legal stay expiring on May the 1st. And unless you want to see an avalanche you should get something done for May 1st. And we get some sort of a kind of ballpark agreement or an agreement of how we are going to go forward in terms of mechanism or strategy as how you want to deal with it. But to me if you get public corporation done, it is a lot of debt that can be handled easily, get it down to the GO and COFINA and get everybody in the room. You know you got May 1st litigation holding expirations and I think you don’t want to see that flop. If you have to play 1000 battles, it is going to totally distract the government and cause a lot of additional expense that they could avoid. So our recommendation is you go it that way that doesn’t mean anything, but I think that is the fast forward we know that that May 1st other than a Title 3 is a hard day. So therefore something has got to happen before May 1st if you are going to have the ability to still continue this in a very controlled environment where there is consensual negotiations, where you are working to get solutions, someone is going to have to make more of a commitment that has been made as you talked about. PREPA has been in the can and it has been picked down the road for two years. It is about time we start kicking the can. Right? That deal was agreed by all parties and whatever modification you want to make, come out and quit messing around, get it done, let's move forward regardless of that outcome because once again that outcome will have consequences for other outcomes. This is a big pot, how the pots get divided and funded is going to make a big difference as to how other people treat other parts of the pot. So if you got rid of the public corporations that will be a great step forward. And as I said, get it down to where you have got your issues which is to mean what the Sovereign, what the actual Commonwealth itself which gets back to the GO and the COFINA. And I will guess how…

No that certainly helps, I understand the timeline. And have you had any conversations with the new administration about what or have any insight as to sort of how they are thinking about Puerto Rico and obligations they are having?

In conversations yes, right we can only talk as much as we can talk. They have not given us a peak of their cards. We I think have put our cards on the table. We are very transparent as we've said and it is their move. And PREPA is a great example of it's their move. And you can now , so you want a relook at the agreement, well okay relook at the agreement, but get it done and you have till May 1st. And that is not the only reason you've got to give before May 1st. You are going to have to have some agreement in principle how you want to go forward while the avalanche is going to happen and although you are going to cry that, oh look this is where you have to avoid what you are bringing it on yourself. We've stayed here for two years with PREPA. We have done all the forbearances. We have done the funding, we have helped in every way we've possibly can to get a resolution to everyone's satisfaction now is the time, you know to get off the pot and do something.

Understood and did the rate increases get codified at Puerto Rico, I mean at PREPA?

I think we are about 50:50 on that mike. So one did, the other one was changed a couple of times if I remember correctly, there was actually another rejection of it most recently but yet they are allowed to still continue after some short period of time. So it's still a political football and as you can imagine and I'm not trying to make light of this thing or making it sound easier than it is. There is the huge political environment here that has to be managed as well. I mean there are 3.5 million Americans there that have to be consistent in any scenario and how is the best way to steer this very complicated situation while still being able to recognize the rights and the conditions of these 3.5 million Americans just still recognized the financial reality which they brought on themselves that has to be addressed, there is no easy solution. Do we think there is a way forward? Absolutely and as I said a little bit earlier the public corporation will be the first way forward, they've got other issues relative to tax policy, tax collections, government, operations, efficiencies of the individual apartment that you saw the, great argument going on at the University of Puerto Rico where they suggested that they, we’re going to made – management resulting. So you can understand this is not politically easy and you could almost fall off the strip in Greece where the first level of use met with absolute revolution, but there is an economic reality that has to be faced and someone is going to get up and account for and take the appropriate responsibility and we worried we – work with them, we are big boys take. We sit at the table every day. We have a very realistically view in terms of what is the way forward and what our responsibility is and we're getting help in any way we possibly can. They do need some federal assistance with this, you know, there is medical reimbursement disparity makes no sense to us, if you are going to call the 3.5 million Americas and how you treat them differently. I don’t see the cause of the ability. And that's a huge number relative to their budget and maybe that's how they are arguing this thing. And so she is trying to get some further action on that part. It is a complication beast and I think Assured as I said earlier in the call, we are well positioned to be an A, we are very well positioned vis-à-vis our legal rights and work either side of the quake [ph] as terms dictate.

Right, thank you, for taking my questions.

You’re welcome.

And the last question will be a follow up from Michael Temple, a Private Investor. Please go ahead.

Yes as clearly as we look at the company over the last two, three years it's been a Puerto Rico story for all the obvious reasons and but at the same time, as you pointed out here in the financials, your core business as a finally showing some extraordinary year-over-year growth reflecting marketplace dynamics. My question for you is as follows, can you recap for us because again you are buying up the legacy businesses of your principal competitors from a decade ago, could you just give us a rough ballpark of your competitive place in the industry say 10 years ago, what was your market share, who were your principal competitors? And then today where it seems like you're the last cowboy standing at the saloon and what the relative market share you think you have and who is your number two or number three as you go about bidding for all these new business initiatives again away from the whole Puerto Rican situation that obviously continues to calm people's mindset about your company?

Well a little quickly just read because I'm not so sure that has helped us much. But 10 years ago we were the smallest company in the industry. We were probably still split range at that time. therefore we were only able to do small transactions [indiscernible] we were very dependent in that market because that market wasn’t as rating sensitive. And our competition then was the other monoclines. Today our major competition is the uninsured market. There is really the market itself in terms of the desire for yield and return in a very low interest rate environment. So we went from having to compete against several other competitors back in the day now we're competing here in some market that's made up of financial institutions, other investors, insurance companies, et cetera that hold this paper and are competing for the yield and therefore not utilizing the insurance product because they want to return as opposed to pay for the insurance. As interest rates spike up however, we see an opportunity for the demand for insurance will increase. As the credit concerns increase we see demand for insurance increase. In the old days the insurance industry wrote 50% of the market. Today we probably don't write half of the market that we used to write. So now the insurable market is half of what it used to be. But I still believe in the long term value of bond insurance that we will rise after that, in other words 50% of the 50% which gets you 25%. So our penetration rates today on an product basis are between 5 and 7 and I think in the right insuring environment we can continue to increase in demand for the product relative to the appreciation of what the product delivers in terms of value we substantially increase over the next few years. And although we have two [indiscernible] out there in the market we think we're in the best position to capitalize on that increasing market share. And we will be kind of you will say the last guy standing at the bottom.

And who are those two competitors that you are up against on daily business out there?

A company called [indiscernible] and company called National. National was the former MBIA company, [indiscernible] is a mutual company that was sponsored by a company called White Mountain. White Mountain just produced its annual results which showed an increasing loss on its exposure to [indiscernible] $600 million of surplus loans which is down and repaid and the principal, nor has been paid any interest. Then the current accumulated interest that is not recognized on a statutory basis, but our competitor is over is over $100 million. So you can make your own conclusions relative to the value of their guarantee.

Thank you very much.

You are welcome.

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'd 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.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.