Good day, everyone and welcome to the Assured Guaranty Fourth Quarter and Year End 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] And please note that this event is being recorded. And now I would like to turn the conference over to Robert Tucker, Senior Managing Director of Investor Relations.

Please go ahead..

Thank you operator and thank you all for joining Assured Guaranty for our 2018 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 are 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 the 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 would like to ask a question.

I will now turn the call over to Dominic..

long-term financial strength to protect our policyholders and continued value creation for our shareholders. I will now turn the call over to Rob..

Thank you, Dominic and good morning to everyone on the call. I am pleased to report a very strong fourth quarter. We generated operating income of $92 million, which compares favorably with $91 million in the fourth quarter of 2017.

Our net earned premiums were $125 million in the fourth quarter of 2018 versus $178 million in the fourth quarter of 2017. This includes premium accelerations of $28 million in the fourth quarter of 2018 compared with $82 million in the fourth quarter of 2017.

We expected this lower refunding activity due to the elimination of the tax exempt status of advanced refundings as well as the reduction in insured portfolio bonds subject to a call provision. With respect to losses, there’s almost no net economic loss development in the fourth quarter of 2018.

Improved performance of the underlying collateral in U.S. RMBS transactions resulted in a benefit of $17 million. However, expected losses increased on certain Puerto Rico and other structural finance exposures. The economic development attributable to changes in the discount rates was a $2 million benefit for the quarter.

This quarter’s results reflect the benefit of a lower effective tax rate. The effective tax rate on operating income in the fourth quarter of 2018 was 11.8% compared with 48.4% in the fourth quarter of 2017. While the fourth quarter of 2018 reflects a lower tax rate in the U.S.

of 21% versus 35% in the prior year, 2017 included a onetime expense of $35 million, representing the implementation of the Tax Cuts and Jobs Act. Excluding the onetime provision related to the implementation of tax reform, the effective tax rate was 28.5% in 2017.

As always, the effective tax rate fluctuates from period to period based on proportion of income in different tax jurisdictions. Moving on to the full year results. Operating income was $482 million in 2018 compared with $661 million in 2017, which included gains from several large transactions.

2017 operating income benefited from $402 million in gains from the execution of strategic initiatives, particularly reinsurance commutations, the MBIA UK acquisition and litigation and R&W settlements, while 2018 operating income was positively affected by the tax reform I previously mentioned and significantly lower loss expense in 2017.

On a full year basis, net earned premiums were down compared with 2017 due to lower premium accelerations, which were $159 million in 2018 compared with $286 million in 2017. Turning to losses, we had a net economic benefit in 2018 of $5 million made up of a benefit of $69 million to improve performance of the underlying U.S.

RMBS collateral and a benefit to our exposure to the City of Hartford, offset by increased reserves on certain Puerto Rico exposures. The economic development attributable to changes in discount rates was a benefit of $70 million in 2018. During 2018, we returned $71 million in dividends to our shareholders.

And this week, the board approved a 12.5% increase in our quarterly dividend to $0.18 per share and authorized additional share repurchases of $300 million, bringing our current outstanding authorization to $350 million.

In the fourth quarter of 2018, we repurchased 3 million shares for $120 million, bringing full year 2018 repurchases to 13.2 million shares or $500 million. These shares were purchased at an average price of $37.76 per share for the year. Year-to-date in 2019, we have purchased an additional 1.2 million shares for $48 million.

Since January 2013, our successful capital management program has returned $2.8 billion to shareholders, resulting in a 49% reduction in total shares outstanding. The contribution of cumulative repurchases since the inception of the program is over $15 per share to operating shareholders’ equity and over $27 to adjusted book value per share.

We currently have over $200 million in cash and investments available for liquidity needs and capital management activities at the holding companies.

As Dominic mentioned, the continued share repurchases, along with the successful execution of strategic initiatives such as 2018’s Syncora transaction, have helped to drive operating shareholders’ equity per share and adjusted book value per share to new records of $61.17 and $86.06, respectively.

I’ll now turn the call over to the operator to give you the instructions for the Q&A period. Thank you..

Thank you. [Operator Instructions] And the first questioner today will be Bose George with KBW. Please go ahead..

Hi guys. Good morning. I am actually looking to start with a question on the outlook for acquisitions and reinsurance. You’ve obviously been some very good transactions over the last few years.

Can you just talk about the outlook there? And also do you need resolution in Puerto Rico or more resolution before we can see more activity?.

Yes. Bose as you know the – we have been obviously very high on the strategic initiatives to acquire or consolidate the rest of the financial guaranty market. And obviously we have tremendous success over the last number of years in that exact area.

As we get down to the remaining possible targets, obviously Puerto Rico does have a rather large impact on it. So to your question from an acquisition point of view I think Puerto Rico’s resolution would significantly accelerate potentially the opportunity on both sides for a transaction to be consummated.

However, looking at the Syncora structure, we went with reinsurance which allows us to provide them capital relief, provide liquidity while taking those risks off their exposure list that we can meet our current requirements relative to underwriting guidelines, overall limits, etcetera while leaving back those other consensus exposure that at this point in time it doesn’t make sense for us to take or obviously we will charge too high of a value that would take away some of the benefits of the transaction.

So both answers apply I think Puerto Rico does provide better opportunities. However, using the Syncora structure as the example we can still go out and provide capital release and therefore still require portfolios not through acquisition but through reinsurance..

Okay, that’s helpful. Thanks.

And then just a couple on the income statement, the increase in operating expenses this quarter was – can you just discuss that and just talk about the run rate for that number?.

The run rate on operating expenses should be similar to what we had last quarter. We had a couple of one-time expenses that we had in the fourth quarter that will not be repeated in the first quarter of this year..

Okay, thanks.

And then actually $18 million, the realized loss in GAAP earnings is that just in the investment portfolio?.

I am sorry I didn’t hear the question..

The $18 million, the realized losses that you have in GAAP earnings is that in the investment portfolio….

Yes. That’s in the investment portfolio..

Okay, thanks.

And then just one more the foreign exchange losses that you called out, those are being pulled out for adjusted earnings, right?.

Yes, they pullback for adjusted earnings, yes they are..

Okay, great. Thanks..

[Operator Instructions] And the next question will be from Geoffrey Dunn with Dowling & Partners. Please go ahead..

Thanks. Good morning..

Good morning..

Good morning Geoff..

Rob, can you breakout on the muni production both par and PVP, the breakdown between primary and secondary?.

Yes. I will get that in a moment..

And then while you maybe taking for that any update on the special dividend out of the operations beyond the regular dividend capacity?.

I’ll handle the special dividend, Geoff. So, obviously as you know for us to continue to be able to achieve our $500 million of capital management projected we need special dividend approval from New York and/or both – and/or Maryland.

Obviously we don’t typically announce that until after we see an approval, so we thus maintain the same goal of $500 million. I think you can be fairly confident that we are really requesting a special dividend and when we get the approval we will let you know..

Is there any reason that didn’t happen in Q4 like it has in the past?.

Well, never, the timing of it really reflects our looking at our cash flow available for share repurchases and to the extent we have enough money.

We don’t need to go back to the world we want to keep this as a kind of an automatic venture with the regulators so that when they get the request, they understand the purpose on it and we get through a very quick approval process. And I would see in 2018 we did meet the $500 million share repurchase target..

And we also have to file 10-K first, Geoff, so we couldn’t give the regulator all the information that they would need..

Okay..

And your first question in public finance primary was $74 million of PVP for the quarter, 2018 secondary markets was $15 million and for 2017 fourth quarter we had $56 million primary and $3 million in secondary.

And for the full year of 2018, I don’t know if you asked that question we had $160 million of primary and $46 million in the secondary market..

And do you have the par breakdown for the quarter?.

Yes. For the par for primary we have – it’s $4.2 billion for primary, secondary is $342 million and last year, it was $4.3 billion and $97 million in secondary..

Alright.

And then moving more to the legal side, how do you think that the recent ruling on the Oversight Board plays out? Are there board members replaced or is this more just light a fire under them to start being more proactive with their mission statement? And then also, as part of that, what does that core ruling mean, do you believe, for the current effort by the Oversight Board to nullify the $6 billion of GOs?.

Well, I think they’re different questions. So, in terms of what happens with the board, your guess is as good as ours. Obviously, the board also had an issue relative to its normal 3-year term expiration in August anyway.

So, whether it’s May or August, that board would have to be either reappointed or replaced at some point in time in the current year.

And obviously, with a stack of litigation that’s now waiting in the courts in terms of appeals, I don’t think anything would be under their auspices finalized unless they start to move significantly back towards the rule of law to resolve some of these open disputes and open cases in the courts.

So, whether they get reaffirmed, replaced, that’s obviously up to the President and the Senate, and we’re obviously very interested in how that ultimately plays out. But the time frame is fairly tight, so we’ll see what happens.

As you said, and if you go back to Congressman Bishop’s letter to the Control Board, they have failed in every aspect in following the law as it was passed by the House and the Senate, PROMESA in terms of their responsibilities to the board.

So, for us, their replacement, obviously, is very, very much appreciated because of the fact we’ve had virtually no cooperation from them anyway, including this attempted repudiation of $6 billion of debt.

And if you go back to the history of law in this area, you would conclude that it’s a very hard climb for them to even get any positive momentum to even accept that.

I mean, when there’s a lot of case law that says if a government basically states that the debt is legal, valid and meets all their tests here, if they try to repudiate it in the future because they’re the ones that have stated it and the bond investor obviously relied on the government’s own assertions, therefore the bond is the debt is still valid regardless of whether it violated some clause at that point in time.

Because the government’s the only one that could have determined that and since they affirm positively that it did, then it’s hard to go back and repudiate.

Plus, from the standpoint of just creditor behavior, you don’t go back to say, I’m going to go look for the opportunity to once again be able to access the marketplace for credit in the future if you provide kind of these kind of behavior. So, at the end of the day, we don’t believe the validity of the $6 billion repudiation.

Worse, we look back at our records and you had bond capital, you had the government making certifications, etcetera. So, once again, that seems to be another folly, but it just shows the continued illegal acts of the board and how they have not followed the responsibility that they have under PROMESA.

So, getting back to the replacement, for us it couldn’t happen sooner, and then we are very much looking forward to August anyway. So, this kind of falls in that same general footsteps. And now the way the Appointment Clause works, as you know, the President has to nominate the people for the position and the Senate has to confirm them.

If you’ll remember, the old board was kind of a hodgepodge of both Senate and Congress and President, and everybody kind of added one from column B and one from column C.

Now you’re at least going to have a focused appointment that theoretically should respect rule of law and provide creditors a more balanced approach to how these restructures are going to be done..

Okay.

If I can sneak one more in, from a just broad and legal framework, do 5 overturned rulings of the Title III Court, does that not have any implication for Judge Swain overseeing this process? Is there precedent for changing judges? Or what does that mean for Judge Swain’s future in this whole thing?.

Geoff, I’m not an attorney, but I play one on TV. And I’ve asked that question a million times to a lot of what I’ll call very experienced legal professionals, and they say being overturned is obviously a very strong statement back to the judge. I can imagine what being overturned 5 times means..

Okay thanks..

And our next questioner, too, will be Brian Meredith with UBS. Please go ahead..

Yes, thanks.

Hi Dominic, I was curious, with the backup in interest rates since the end of third quarter, what’s your kind of view or any updated views on when you would potentially see your new business exceed the runoff of the unearned premium book?.

Well, remember, we had this issue relative to the amortization of the portfolio that so 2 things are going to really start to see new business and growth, right? One is either the market really starts to provide greater opportunity for insured transactions and, therefore, production goes up, premium goes up, par insured goes up.

Or conversely, the amortization of the existing portfolio slows down to where it’s now normalized amortization, and, therefore, new business, reinsure replace the old business that runs off.

As you know, in the last 5 to 6 years, we’ve had incredible accelerated amortization through refundings, through our own commutations, through our own decisions, so that the portfolio has been artificially impacted by our behavior and the market’s behavior relative to the existing book of business and how fast it amortized.

We’re now seeing that slow down. As Rob mentioned in his talk, refundings are virtually slowing down. And if you look at the year, it’s now subject to calls. There are, a lot smaller production than in the prior years that were subject to calls. So, we think the rapid amortization slows down, and, therefore, new business has been picking up.

As we talked about, we had our best year since 2010 in public finance. We’re seeing more opportunities in the international infrastructure market. We’re making smart strategic investments to vertically integrate that specific area and opportunity. So, we’re seeing the grassroots of new business production growing.

And therefore, we think there is going to be an inflection point probably somewhere either later this year or next year where we finally get the runoff of the portfolio to be slower than the new business development. Therefore, we should just start to show positive trends.

Now remember, this year, we did finish the year with greater unearned premium reserve than the prior year. So, we did add to the store, although it didn’t really show up in the par because we aren’t getting paid more for our risk. If you divide par and the premium and so the premium rate’s higher by about one-third year-over-year.

So, we are getting paid more for our muffler. We just don’t get that many opportunities in a low interest rate environment. And as you can see, every time there’s been a positive move in interest rates, there’s been some global concern over economic activity that makes central banks kind of throttle back on the pace of the increases.

So, do we ever get to that really hot interest rate market of, say, a 4.5% 10-year Treasury or so? And but at the end of the day, it’s hard to see clearly through to that.

However, as I said, with the slowdown and rapid amortization and continued growth in our new business prospects, we believe that there will be a positive movement somewhere in either ‘20 end of ‘19 or early ‘20. And of course, any of these acquisition transactions that we can possibly make would obviously have a significant impact on that as well..

Right. Right, right.

And then and just to follow up, you said my other question was, what’s driving that increased pricing that you’re seeing or increased premium per dollar par?.

Well, remember, we are the only kid in town. [indiscernible].

Okay.

So, is it your efforts or the securities that you’re doing?.

Pardon me?.

Like I said, is it basically just your pricing or is it the type of transactions you’re writing that’s required that are..

Oh, combination of both. Remember, let’s not kid ourselves. Mix of business has huge impact. And as we talked about, the influx of health care this year, obviously that carries a lot higher premium rate. So yes, that will also benefit. So, mix of business is as important as does pricing.

But remember, we always talked about, and especially when we talk to the rating agencies, if you look at pricing in 2005 versus pricing in 2018, the 2018 pricing is a lot stronger. And once again, you had 8 people trying to fight for a piece of food back then.

Today, especially when you get to the larger transactions of the more sophisticated issuers, there’s basically us. So, we don’t have that same level of someone beating a 20% use of the savings between a wrapped and the unwrapped price. Now on average, we get between 50% and 60% of the difference between wrapped and the unwrapped price.

So, it is a different pricing market without question. But also, mix of business has an impact as well..

Right.

Is it does he can I also assume then that the return on kind of required capital per transaction has actually gotten better this year than last year?.

Of course. And remember, we always have a we do a calculation by deal of return on the deal. So, we have our own thresholds of what we’re looking for. Obviously, our models hold capital to legal final.

Of course, under the municipal business that you get a high level of refundings, typically you get to cash that capital in literally no worse than half the time you would normally think to hold it. So, the returns are always going to be fairly beneficial. I mean, in the international markets, the returns in that market have always been really strong.

And of course, in that market, there is nobody else left to provide a wrap solution. So, when we look at the overall balance of our book and especially as international and structured write bigger pieces than they have in the past, that drives up the overall ROE on the new business that we write..

Great thank you..

And our next questioner today will be Bose George with KBW..

Yes, I’ve got a follow-up on Puerto Rico.

Can you just talk about your thoughts about any potential consensual restructuring at PREPA?.

Well, we’ve had a deal on the table for PREPA for how long. We had a deal that was approved by 2 governors, by the utility commission, by everybody. And then all of a sudden, the Control Board stepped under which they had no right to under the laws of PROMESA. All prior agreements were supposed to be grandfathered in.

Once again, this is another indication of the rather horrific behavior of the Control Board. So back to the earlier question about their replacement, once again it’s a good idea since they have not followed the law at all. So, we think that there’s a deal out there to be done. There’s, tons of negotiation going on, as you can well imagine.

I think the COFINA deal that paid 93% to the seniors bode really well for the Commonwealth general obligation because the Commonwealth general obligation has the strongest legal claim.

And once again, if you’re going to agree to give $0.93 to the COFINA seniors, what are you going to give to Commonwealth general obligation guys? PREPA is just another subsidiary of that, but PREPA seems to be easier to solve because it’s a, in effect, separate public entity that has its own revenue base, etcetera.

Obviously, it’s been mismanaged to incredible proportion and continue to enter into these weird contracts with small companies that just got initiated. You have to get the contract to do something on behalf of PREPA. We need to get that receiver in. We’re going to be back in the courts, I think it’s in May, to put our request for receivership in there.

I think that’s going to be a real accelerant to a settlement because I think the last, thing they’re going to want is have us behind the door. So, I think things can happen very quickly. And I think with this last overturn, that’s another indication that the rule of law is going to be applied by the courts, and that’s got to be very concerning.

And remember, there’s still another decision to come out of the appellate on the clawback of the transportation revenues. If that gets reversed as well, I think this creates a very open environment that really does signal very strongly back to the Puerto Rican government and the Control Board that games are over, you need to start paying your bills.

And the most insulting part of all this, no matter what fiscal plan they come out with, with how much surplus that’s available, there is no debt service ever provided in the fiscal plan, and I think that’s just an absolute disgrace, mismanagement, call it anything you like.

I think that’s absolutely pathetically behavior of the Control Board, the judge and the Commonwealth and how they’ve looked at this thing. They’re just playing a game to try to get the best deal they can in the market, and thank God we’re not willing to play any games. We’re more than happy to stay with the courts and have our rule of law upheld..

Okay, that’s helpful. And again, just so let me just throw in one more. The S&P has proposed revisions to the kind of criteria for analyzing capital adequacy for the bond insurers.

Anything in there that to call out that might be interesting?.

There is a whole lot of things to call out that are interesting, Bose. But I’m just not going to go to that level of detail until we get further clarification that it will go through. But as you know, that’s an attempt to bring the financial guaranty industry more in line with the rest of the insurance companies that they rate.

And therefore, some of the changes and guidelines, if you read it, are, I think, very beneficial to us as a financial guarantor and not the least of which is the capital credit for assets held on balance sheet. So, in the past, as you know, anything below A was 100% capital charge.

And yet, it really made no sense when you think about a BBB security that S&P would have as its own probably default, say, under 2%. We took 100% capital charge on it. That make no sense.

So obviously, as you look at those revised investment guideline capital charges, that alone would allow Assured Guaranty to more, on a diversified basis, manage its investment portfolio across a lot of rating categories that would allow us to boost significantly the return of the portfolio.

And at $10-plus billion, that’s a pretty good opportunity for us to create income..

Okay great. Thank you..

You are welcome..

And this concludes our question-and-answer session. I would now 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 and you may now disconnect your lines..