Assured Guaranty Ltd.

Good morning and welcome to the Assured Guarantee Limited Third Quarter 2022 Earnings Conference Call. My name is Bailey and I'll be the operator for today's call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note that this event is being recorded. I would now like to turn the conference over to our host, Robert Tucker, Senior Managing Director, Investor Relations and Corporate Communications. Please go ahead.

Thank you, Operator, and thank you all for joining Assured Guarantee for our third quarter 2022 financial results conference call. Today's presentation is made possible 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're 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. Turning to the presentation, 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 assuredguaranteed.com. Turning to the presentation, our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Limited, and Rob Balanson, our Chief Financial Officer. After their remarks, we'll 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. We continue to build shareholder value of Assured Guaranty during the third quarter and first nine months of 2022. As of September 30th, 2022, assured guarantees adjusted operating shareholders' equity per share of $91.82 and adjusted book value per share of $137.87 were both record highs. Adjusted operating income per share of $2.11 for the third quarter and $3.88 for the first nine months represented increases of 369% and 49%, respectively, compared with last year's periods. New business production continue to be strong in the third quarter with 95 million of PVP. It's substantially the same as in the third quarter of last year and our best quarter so far this year. This year's third quarter was our best third quarter in international public finance and second best in US public finance in more than a decade. We believe there's been a permanent shift in the market toward a greater appreciation of our value proposition as the pandemic, the volatility in the markets in the global economy, geopolitical unpredictability, and climate-related natural disasters have reminded investors of the vulnerabilities of their investments. Municipal bond yields, which had risen dramatically in the first half of this year, continued to climb in the third quarter, with the benchmark yield for 30-year AAA geo bonds finishing at 3.9%. Credit spreads remain tighter than have been typical over the past decade, although they have widened somewhat over the course of the year. While interest rates increases and credit spreads widening are promising facts, U.S. municipal bond issuance volume has not kept pace with last year's. There have been fewer refundings this year, wherein past year's refundings have helped drive high total new issue volumes during the year of ultra-low interest rates. Additionally, year-to-date demand has been curtailed by approximately $92 billion in net outflows from municipal bond funds and ETFs. Even with the reduced issuance volume, this was the third consecutive year in which insured volume in the primary market exceeded $21 billion during the first nine months. You'd have to go back to 2009 to see a higher insured volume. At 7.8% of part issued, the industry penetration rate was the second highest in over a decade for the first three quarters. For a sure guarantee year to date, strong demand for our secondary market municipal bond insurance also had some of the impact of lower overall issuance. In the secondary market, we wrote more insured part in the first three quarters of 2022 than in any first nine-month period of the last decade. Our $2.2 billion of secondary insured PAR totaled more than 11 times out of last year's first three quarters. With fewer opportunities to purchase insured bonds in the primary market, investors have evidently been seeking the security and other benefits of our guarantee through the secondary market, which we believe is a sign of fundamental demand that is likely to be reflected in the primary market as volume returns. Holders of uninsured bonds may also want insurance because it has the potential to stabilize the market value of a position compared to the uninsured position should a credit come under financial stress. Our secondary market policies command comparatively higher premiums and have made an important contribution to our strong PVP this year. Assured guarantee remains the market leader for bond insurance, insuring approximately 56% of all primary market insured parts sold during the first nine months of 2022. In total, our insured PAR sold in the primary and secondary markets was $15.1 billion, the third largest amount we have insured during the first nine months of any year in the last decade. This included $4.8 billion of PAR from 21 U.S. public finance transactions that each involved at least $100 million of insured PAR. During the third quarter of 2022, our insured PAR sold in the primary and secondary markets totaled $3.4 billion, of which $480 million was secondary market PAR. We were pleased to continue to add value on AA credits, where we believe investors see our guarantee on high-quality credits as a mitigating of various risks. During the third quarter, we insured $683 million of PAR on 24 primary and secondary transactions with AA underlying ratings. In aggregate, for the first nine months of 2022, we insured more than $2.3 billion of PAR on 103 primary and secondary market transactions that either S&P or Moody's or both had assigned AA underlying ratings. Outside U.S. public finance, our international public finance business had its best third quarter since 2009, producing $37 million of PVP and bringing its year-to-date PVP to $67 million. We guaranteed the transactions in the transportation, airport, water, and other utility sectors. We have good prospects for a strong finish to the year, including local authority debt and other transactions. In global structured finance, we are currently processing mandates in such areas as subscription finance, diversified payment rights, whole business securitizations, and portfolio capital management for banks and insurance companies. Our new business production benefits from our strong financial strength ratings. Last month, Crow Bond Rating Agency affirmed the AA plus ratings it applies to our US, UK, and European insurance subsidiaries. In separate reports on AGM and AGC, KBRA highlighted the company's substantial claim-paying resources, ability to withstand KBRA's conservative stress scenario losses, and our skilled management team. Also last month, the Puerto Rico Highway and Transportation Authority settlement and plan of adjustment was approved by the district court in Puerto Rico, and the plan is expected to be implemented before year-end. Resolving HTA reduces our total remaining insured Puerto Rico net par exposure to about one-half of 1%, of our total insured portfolio. With regard to PREPA, after mediation had reached an impasse, the court had allowed certain litigation to proceed, while directing further mediation to resume concurrently. The PREPA bonds have robust creditor protections, but as always, we prefer to resolve the matter consensually if possible, as we have attempted to do for many years. Overall, our insured portfolios have improved significantly in the last five years. with below-investment-grade exposure diminishing from 4.8% of mature net-poor outstanding in September of 2017 to 2.5% today as a result of our loss mitigation efforts. And it's important to remember that only a portion of the BIG exposure is ever likely to produce actual losses. As many of you know, we acquired our asset management business in October of 2019 with the aims of, one, diversifying our revenue sources by adding a fee-based revenue stream, and two, getting an in-house platform to increase our investment returns through alternative investments. We refocused the firm and have now almost fully wound down the legacy funds that we wish to exit. In terms of our key objectives, as of September 30th, our asset management business had more than $17.5 billion of assets under management, substantially all of which is fee earning. In comparison, at the end of 2019, with a comparable amount of AUM, less than half was fee earning. We also made progress on the second objective, Since we've been investing in insured IM funds, those investments have generated an annualized internal rate of return of over 10%, which is markedly higher than any other insurance segment investment. Keep in mind, these investments are marked to market on the income statement and will therefore show more volatility than our fixed income investments. However, the current marks do not change our expectation of our ultimate returns. Capital markets have continued to experience volatility. In October, the 10-year Treasury yield went above 4% for the first time since 2008, And last week, the Open Market Committee added another 75 basis points to the Fed funds rate. In the municipal market, the benchmark yield on tax exempt AAA 30-year GOs also exceeded 4% last month, a level last seen in January of 2014. In the muni market, yields are roughly now 260 basis points higher than what they averaged in 2021. Given the current environment of higher interest rates and what appears to be a weakening economy, we would expect to benefit from further spread widening and a potential return of municipal insurance volume to higher levels. If these occur, demand for municipal bond insurance should increase. And I can tell you that so far in October, in the fourth quarter, the municipal market saw greater insured penetration, while assured guarantee increased its market share, found more frequent opportunities to insure transactions with larger par amounts. We also believe that in volatile global markets, many participants in infrastructure and structure finance are likely to have good reasons to employ the versatile tools we offer to manage the risk. Our outlook is positive as we continue to focus on our core principles of discipline risk management, excellent customer service, and prudent capital management that is optimized for the benefits of our policyholders, clients, and shareholders. I'll now turn the call over to Rob.

Thank you, Dominic, and good morning to everyone on the call. I am pleased to report strong adjusted operating income in third quarter 2022 of $133 million, or $2.11 per share. This represents a 369% increase on a per share basis compared with the third quarter of 2021. As a reminder, in the third quarter of last year, we refinanced $600 million of long-term debt, which resulted in a $130 million loss on the extinguishment of higher coupon long-term debt. Third quarter insurance segment adjusted operating income was $159 million compared with $214 million in the prior year. These results include strong and relatively predictable scheduled earnings generated by our financial guarantee contracts and fixed maturity investment portfolio, offset by some fair value movements in other investments. In terms of premiums, third quarter 2022 net earned premiums and credit derivative revenues were $92 million compared with $114 million in the same period of last year. The decrease relates primarily to $13 million of net earned premiums on certain transactions in the third quarter of 2021 that did not recur and lower accelerations and updates to debt service assumptions in the third quarter of 2022. The fundings were $12 million in the third quarter of 2022 compared with $15 million in the third quarter of 2021, which is consistent with our expectations. Deferred premium revenue on the investment-grade exposures has been approximately $3.5 billion for each of the last eight quarters, as our new business production has replenished the normal amortization of the enforced book of business. As Dominic mentioned, financial guarantee new business production was strong in the third quarter of 2022, despite reduced primary market issuance. higher interest rates, and a more active secondary market contributed to a stable level of deferred premium revenue. Net investment income from the available sell and short-term investment portfolio is also a relatively predictable stream of income and was consistent on a quarter-over-quarter basis at $69 million. As Dominic also mentioned, the economic environment characterized by market volatility and rising interest rates impacted several components of adjusted operating income, adjusted operating shareholders' equity, and adjusted book value. The largest component of the quarter-over-quarter variance for the insurance segment's adjusted operating income is the fair value movement attributable to investments. Specifically, fair value losses related to alternative investments in the third quarter of 2022 of $11 million compared with gains of $33 million in the third quarter of 2021. This includes investments in Assured IM funds whose inception to date mark is a pre-tax gain of $107 million, representing a 10.3% annualized return. This is in line with our targeted return, demonstrating the value of our investment diversification strategy to enhance overall returns. With respect to the Puerto Rico contingent value instruments, The company received these instruments in the first and third quarters of 2022 under the GEO PBA plan and HTA support agreements. And we now manage these recoveries as trading securities. In third quarter 2022, the related fair value loss was $8 million on a pre-tax basis, primarily due to rising interest rates. Economic loss development, which was a net benefit of $72 million in the third quarter of 2022, was also affected by the rising interest rate environment as it included a benefit of $25 million related to higher risk-free rates used to discount expected losses. The economic benefit was mainly driven by a $95 million benefit in U.S. RMBS, which had several components, including a benefit related to the purchase of a loss mitigation security, a benefit on assumed RMBS where we shared proportionally in exceeding companies' rapid warranty settlement, and additional benefits related to updated second lien default assumptions, higher recoveries on charged off second lien loans, and improved performance in certain other transactions. The net effect of economic loss development and the amortization of related deferred premium revenue resulted in a benefit in loss expense of $75 million in the third quarter of 2022. The asset management segments adjusted operating loss was $3 million in the third quarter of 2022. An improvement over last year's adjusted operating loss of $7 million. The more favorable results were due to higher asset management fees compared with third quarter of 2021 as the increase in fee earning opportunity fund AUM more than offset the decline in AUM associated with the wind down funds and lower segment operating expenses. As of September 30, 2022, we have only about $200 million of AUM in our wind-down funds, compared with $800 million of AUM as of September 30, 2021. AUM in Opportunity Fund as of September 30, 2022, was $2 billion, up from $1.6 billion as of September 30, 2021, due to fundraising in our healthcare strategy. Foreign exchange rates also moved significantly in the third quarter. And while the strengthening US dollar relative to the British pound does not have a material effect on adjusted operating income, it can have a material effect on GAAP net income, as well as all of our non-GAAP book value metrics. The effective tax rate is a function of taxable income across tax jurisdictions and varies from period to period. In the third quarter of 2022, the tax provision includes a $20 million benefit attributable to a return to provision adjustment. With respect to our capital management objectives, we repurchased 1.8 million shares for $97 million in the third quarter of 2022. Subsequent to the quarter close, we repurchased 785,000 shares for $42 million. As of now, the remaining authorization to repurchase shares is $261 million. Continued share repurchases, along with our positive adjusted operating income, new business production, and favorable loss development have increased operating shareholders' equity and adjusted book value per share to new records of over $91 and $137, respectively. While quarterly operating results vary from period to period, the consistent quarterly increases in these book value metrics reflect how the successful execution of our key strategic initiatives build shareholders' value over the long term. Since the beginning of our repurchase program in 2013, we have returned $4.6 billion to shareholders under this program, resulting in a 72% reduction in total shares outstanding. From a liquidity standpoint, the holding companies currently have cash and investments of approximately $127 million, of which $75 million resides in AGL. These funds are available for liquidity needs or for use in the pursuit of our strategic initiatives to either expand our business or repurchase shares to manage our capital. 2022 has been a year of great progress, particularly in terms of our Puerto Rico exposure. Aside from PREPA, our remaining exposure to defaulting Puerto Rico credits are covered under the HTA plan, for which we are awaiting the effective date to be announced. In third quarter, we received $147 million in cash and $617 million in original notional contingent value instruments as part of the pending HTA settlement. Our exposure to Puerto Rico salvage assets in the form of recovery bonds and CVIs have also been declining as opportunities arise to sell those securities. During the third quarter, we sold approximately 20% of par or notional value of the amounts received under the settlement agreement. for a total reduction of 48 percent on a year-to-date basis. In addition, $87 million of the CBI is paid down subsequent to quarter end. As we look forward to the fourth quarter and beyond, we remain optimistic that the interest rate environment will benefit new insurance business production, and asset management and alternative asset strategies will continue to contribute to the company's progress towards its long-term strategic goals. I'll now turn the call over to our operator to give the instructions for the Q&A period. Thank you.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. To withdraw your question, please press star, then 2. If you're using a speakerphone, please pick up your handset before pressing the keys. At this time, we will pause momentarily to assemble our roster. The first question today comes from the line of Brian Meredith from UBS. Please go ahead. Your line is now open.

Hey, thanks. A couple questions here. First, I'm just curious, Dominic, there was a disclosure by NBIA that they're undergoing some strategic evaluation of Barclays. I'm just curious your kind of thoughts on whether that would make a good strategic fit with AGO. Any opportunities there?

Well, Brian, thanks for the question. We heard that same comment in the market as well. Obviously, we've been continued as one of our strategic objectives was always to consolidate the other remaining monolines. And like any other opportunity, we'll look at it if given the opportunity and see if it makes sense and whether we can meet the credit terms of our credit underwriting standards and what else is in the portfolio.

Great, thanks. And then second question, I'm just curious, to look at the dividend capacity, you know, out of the insurance ops right now, it's relatively low. Maybe give us kind of the views of maybe a special dividend, particularly, could you get one when HTA ultimately, you know, comes through and everything finally gets done?

Well, I'll let Rob answer the specifics. But yeah, we obviously look at other, all means in terms of meeting our cash flow requirements of the holding company that allows us to operate or execute our strategic objectives, one of them, which is capital management. Obviously, as Puerto Rico continues to wind down, we get down to basically one exposure, which is PREPA. And remember, the regulators were giving us special dividends even with Puerto Rico back in the day, and then obviously COVID hit and that changed things dramatically. So we think the environment is getting in the right structure for us to go back to the market or go back to the regulators and have the discussion about special dividends, obviously, as we want to achieve further strategic objectives, that's important for us to be able to accelerate or increase our cash flow to the holding company.

And Brian, you know, as you look at page 12 of the equity investor presentation, you can see the remaining capacity at AGM and AGC, but that's just for this year. So that will be replenished in the next year. So remember, it's either 10% of policy over surplus or your net investment income. So that will be replenished in addition to which AG Re will have more capacity going into next year as well. And obviously we're always looking to increase that dividend capacity through possible dividends from our UK operations. And so we continue to try to maximize our dividend capacity with our operating subsidiaries.

Gotcha. And I want to go just quickly back to my first question. I'm just curious. From your perspective, is there the ability for AGO to do a transaction for all of MBIA, or would you be purely focused on national if something was possible?

Well, that's pretty speculative, Brian. So at the end of the day, we really, at this point, we've looked at the portfolio from a reinsurance perspective over time, but obviously we'd have to do a complete update of our understanding of what's in each of the organizations and see what makes sense. And if there's something that makes sense, then obviously we would consider it. Great. Thank you.

No problem. Thank you. As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad. The next question today comes from the line of Tommy McJoyne from KBW. Please go ahead. Your line is now open.

Hey, good morning, guys. Thanks for taking my question. Good morning. Yes, I won't ask specifically about your interest in MBI, but just perhaps from your seat, kind of a unique standpoint, do you think that other multi-line insurance companies might have interest in an asset like that? I guess said another way, is it possible that other insurers could aim to enter the bond guarantee market, I guess with a positive outlook of higher rates and wider spreads? Or is the stigma of Puerto Rico really likely to keep some entrants away from this market?

Well, speaking from a third-party perspective, I don't think the stigma of Puerto Rico makes any difference at all at this point in time. I think it's a credit that's getting its way to resolvement. Obviously, based on the creditworthiness of the government and the activities and its actions would make it difficult for them going forward to get further bond insurance applied to any of their debt. that's for another day. So I don't think Puerto Rico matters at all. I think it really looks at the regulatory environment. So remember, when you get into this business, you not only have regulators, you have rating agencies, which are two very high hurdles. And if a company is willing to climb those hurdles, then they would take a look at it. But for us to try to speculate on whether a P&C company or a title company or a life company wants to get in the financial guarantee business, hey, we welcome the competition. I think Assured is very well positioned relative to the marketplace, to our standing with our clients, and the performance that we've done in the You know, track record that we've been in a mess, which is not easy to duplicate at this point in time. Plus, as we've always said in this business, you need a track record. You need earnings. You need a deferred revenue source to really make it sense to put the capital in play. So if you say these companies that are left big enough to establish that benchmark or that foothold to allow you to go forward in the business, like I said, it's not for us to determine. It's just to determine whether it's attractive to us or not. And if we see competition, then we see competition.

Got it. Thanks. I guess on that topic of thinking about regulators and rating agencies and dealing with both, I guess on the topic of a special dividend and the potential size of it, do rating agencies look at it really differently than regulators might? I know you guys were trying to work on coming up with an updated figure of the, I think it was an S&P report, kind of estimating how much excess capital you had in excess of a AAA rating. That was, I think, last out in 2019. So just any update on that and really just kind of thinking about how regulators look at it from the perspective versus rating agencies.

Well, I think the regulator and rating agencies do have different perspectives, right? Obviously, the rating agencies are more based on a stress-loss scenario. Regulators have a lot more criteria. They have a different capital model than the rating agencies do. And yet, as a financial guarantor, you're probably responsible for both. In terms of the excess capital, so we anticipate the question. So the numbers come down over the last two years due to our success. I'm reading a prepared remark, so bear with me on this. So the numbers come down over the past two years due to our successful capital management program, basically resolutions related to Puerto Rico, and we're very comfortable that we have substantial excess capital. The last time we gave you this information was for a year in 2019 where we had approximately $2.6 billion of S&P AAA excess capital. Very important to note it's on a AAA basis. However, between then and the year end 2021, we repurchased $1 billion of our common shares, $1 billion worth of common shares, paid approximately $140 million in dividends, paid over $700 million of PR debt service, excluding settlements, invested over $500 million through AGS and other high cap charge investments. And despite using this $2.14 billion of capital, Our S&P excess AAA capital is still $1.8 billion as of year-end 2021. So hopefully that gives you your answer.

Yes, that's what we were looking for. Thanks for having that prepared for us. No problem. And then just a last question, and I think it looked like in the slides that the industry's U.S. public bond insurance penetration rate Actually, it looks like it dipped a little bit in the third quarter, just if I see the penetration in the first half and compare it to what it was for the first nine months. So it looks like it declined a bit sequentially, which is a bit surprising given the backdrop. Any sense of what drove that?

Yeah, I mean, remember, that's very relative to who's in the marketplace at any given period of time. And, of course, the market volume is way, way down. So the issuers that are in the market are probably the more liquid issuers that are probably going to lose bond insurance lease. I think as you see the statistics for the complete year, you'll get a very different answer relative to the penetration rate. It's still kind of flat with the prior year, which is still way above years, you know, four or five years ago. So we're making progress in penetration. We think with the rising interest rates, the widening of credit spreads, the economic uncertainty, we think demand is now positioned to really start to increase substantially. And we'll hopefully see that in the fourth quarter when we give you our fourth quarter and year end statistics.

Great. Thanks for answering those questions.

No problem.

Thank you. The next question today comes from the line of Jackie Kavanagh from Putnam. Please go ahead. Your line is now open.

Hi, guys. Can you hear me okay?

Yeah, we can, Jackie. How are you?

Hi. Hi. Thank you so much for taking my question. I guess just a follow-up to the prior question, and thanks for going through the different capital sources. Does the regulator or the rating agencies care at all about the AOCI marks, and does that impact their analysis or the way they might think about a special or the capital excess, just given the magnitude of the marks? Thank you.

The mark doesn't have an effect on statutory capital, and it doesn't have an effect on rating agency capital. Obviously, it would be a discussion that we talk about with rating agencies, but it doesn't affect surplus or rating agency capital.

Okay, great. So they're sort of agnostic to it, just like the street kind of looks through it.

They don't look through it. It's just not part of their model. So one looks at claims-paying reserves, one looks at statutory capital, which just doesn't count as statutory capital, or doesn't affect statutory capital.

S&P starts with our surplus and stock capital, and then rating agencies just, obviously, I mean, the regulators will look at surplus, and... But as Dominic said earlier, there are other regulatory tests that we need to talk about with them and deal with them when it comes to getting special dividends.

Got it. Okay. I know you've told me that before, but I just wanted to confirm, given the magnitude of the

and everything else relative to the organization.

I'm sorry, Jeff.

Right. And then just financially, is there any kind of return leverage preference between reinsurance versus an outright acquisition?

Well, in the old days, the outright acquisition had a lot of benefits, right? It got us the portfolio re-rated, boarded the investor base, which we really don't need anymore, but that was important to us back in the day, like the FSA transaction.

And then we got huge discount on the capital, and the capital was substantial to get a discount on. Now, the capital base is early.