Earnings Call Transcript - AGO Q2 2024

Operator, Operator

Good morning, everyone, and welcome to the Assured Guaranty Limited Second Quarter 2024 Earnings Conference Call. My name is Rune, and I'll be operating your call today. All participants will be in a listen-only mode. After today’s presentation there will be opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference call over to our host, Robert Tucker, Senior Managing Director, Investor Relations and Corporate Communications. Please go ahead.

Robert Tucker, Senior Managing Director, Investor Relations and Corporate Communications

Thank you, operator, and thank you all for joining Assured Guaranty for our second quarter 2024 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're listening to a replay call, after 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 Limited; Rob Bailenson, our Chief Operating Officer; and Ben Rosenblum, 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.

Dominic Frederico, President and CEO

Thank you, Robert, and welcome to everyone joining today's call. Assured Guaranty had an exceptional second quarter and first half of 2024. Adjusted operating income per share came in at $1.44 for the second quarter of 2024 compared with $0.60 in the second quarter of last year. Our key shareholder valuation measures again reached new per share highs. Since June 30, 2023, on a per share basis, shareholders' equity rose 16%, adjusted operating shareholders' equity rose 15% and adjusted book value rose 12%. New business production for the first half remained strong, consistent with recent years results, and was diversified across U.S. public finance, international infrastructure, and global structured finance. The first half PVP of $218 million was more than in any first half since 2009, with the sole exception of the first half of 2018 when we assumed a large portfolio from another bond insurer. Rob will give you more production details in a few minutes. But first, I want to discuss the merger we completed last week of Assured Guaranty Municipal into Assured Guaranty Inc., which is the same company you have known for many years as Assured Guaranty Corp. The rationale for separating no longer exists; we see the merger as beneficial to all of our stakeholders. Assured Guaranty Inc. is the surviving company, and its acronym is simply AG. This simplification of our brand marketing is only one of the many benefits. Two of the primary objectives of the merger are to achieve more efficient utilization of the combined capital of the two companies and to increase operating efficiencies. This includes having one principal U.S. regulator, Maryland. By aggregating the two platforms into a single insurance company, the merger enlarges the pool of capital and claims-paying resources available to support the insurance policies and results in further diversification of the single company's insured portfolio's credit profile. Both companies' insured portfolios included public and infrastructure finance exposures, as well as structured finance exposures. The combined company will continue to serve the same markets. To be clear, all obligations of AGM are now obligations of AG, and all of their policies have the same terms as when they were issued. AGM's U.K. and European subsidiaries are now subsidiaries of AG, at the time of the merger, AG and AGM had identical financial strength ratings: AA+ at KBRA, AA at S&P, and A1 at Moody's, all with stable outlooks. All three rating agencies have indicated that they see no change to Assured Guaranty's financial strength rating as a result of the merger. KBRA noted that it viewed the merger and the resulting simplification of the overall organizational structure as creating capital, operational and regulatory efficiencies, as well as enhancing Assured Guaranty Limited's overall global platform and scale. Moody's believes the merger results in a moderate strengthening of AG's profile relative to that of pre-merger AG and AGM. S&P has always rated our guarantees based on the capital allocation of the entire group, so was already accounting for the companies' exposure. Prior to the merger, AGM and AG were each overcapitalized and both experienced a substantial reduction in their insured exposure since 2010, while statutory capital increased materially during the same period. In connection with the merger, we upstreamed $300 million through a special dividend, technically a stock redemption, that the Insurance Administration approved. This was followed by a $100 million stock redemption by AGM during the second quarter. Rating agencies considered these transfers when assessing the combined company's ratings. There is more information about the combined company in the presentation on our website, where you can also find a Q&A with more details about the merger, our press release about both the merger and the rating agency's decisions and the full rating agency announcements. With the consolidation of the MERS subsidiaries, the new AG is very well positioned for future growth and efficient operational success, building on Assured Guaranty's excellent first half of 2024 production and financial results. We remain committed to our share repurchase program with a target this year of $500 million. As of August 6, 2024, the company had repurchased 7.2% of the shares that were outstanding on December 31, 2023, and was authorized to repurchase an additional $275 million of its common shares. In June of this year, we saw a favorable ruling in the restructuring case of Puerto Rico's Electric Power Authority, or PREPA, our last remaining nonpaying Puerto Rico exposure. The appeals court reaffirmed several lower court findings, noting that the utility's bondholders had a perfected lien, not just on trust agreement accounts but also on past, present, and future net revenues. The appeals court also determined that investors' allowed claims would amount to the face value of the utility bonds plus interest, amounting to about $8.5 billion—this is more than the prior cap of $2.4 billion set by the lower court. The lower court has ordered the parties to resume mediation in light of the appeals court ruling, and we look forward to working with all stakeholders to reach a fair resolution of the PREPA restructuring. Uncertainty this year regarding economic, geopolitical, and financial volatility reminds investors why it's advantageous to have investments that are protected by our insurance. Our guarantees have unique value, providing investors protection from what can be unpredictable, and bond issuers can reduce their financing costs by issuing bonds with the extra protection of our guarantee. Assured Guaranty has proven its reliability over the past four decades, consistently meeting our obligations and returning excess capital to our shareholders while maintaining a high level of financial strength, based on predictable earnings and market leadership. We have high potential for growth in our worldwide financial guarantee business. With our new, more efficient organizational structure, we believe we’ve never been better positioned to serve our clients, protect our policyholders, and create value for our shareholders. I will now turn the call over to Rob to discuss our production results.

Rob Bailenson, Chief Operating Officer

Thank you, Dominic. Assured Guaranty, and in particular, U.S. public finance, had very strong first half results for 2024. In fact, it was one of our strongest production halves since 2009. As Dominic mentioned, new business production for the first half continued to be diversified across U.S. public finance, international infrastructure, and global structured finance. The first half PVP of $218 million was the largest amount of total first half PVP since 2009. With the exception of the first half of 2018—when we assumed a large portfolio from another insurer—this trend sharply increased our PVP results. Bond insurance penetration remained comparatively high at 8.2% for the first half and 8.9% for the second quarter of 2024, a continuation of the increased demand for bond insurance that we have seen since 2020. Bond insurance is increasingly being utilized across a variety of transactions, ranging from very small to very large in size. We believe that more investors have realized that, in addition to the security provided, our bond insurance can potentially support price stability and market liquidity, and that issuers are using it to obtain greater certainty of execution in less predictable market environments, in addition to reducing financing costs. Assured Guaranty continued its market leadership position for the first half of 2024, issuing $10.8 billion of primary insurance, which represented 56% of the insured par sold in the primary market. Year-over-year, for the first half of 2024, Assured Guaranty's primary market insured par increased by 11%. In the second quarter, Assured Guaranty's primary market share was 58%, based on a 13% increase year-over-year in insured primary market par sold for a total of $7.2 billion. One driver of our production is the ongoing demand for our guarantee on larger transactions, which typically see interest from institutional investors. For the first half of 2024, Assured Guaranty insured 21 transactions that each utilized $100 million or more of Assured Guaranty insurance, 14 of which were in the second quarter. We saw significant opportunities in large, high-margin transactions during the first half, including three of the largest transactions sold in the municipal market: $1.1 billion of insurance for the Brightline Florida passenger rail project, where we insured a majority of the senior bonds; $800 million for the new Terminal 1 at John F. Kennedy Airport; and $831 million for a dormitory authority of the State of New York school district revenue bond issue. The Brightline project is the first private sector passenger rail system built in the U.S. in over a century. The JFK project is the largest U.S. public-private partnership transportation project and the issue helped 69 school districts finance capital improvements. We were pleased to continue adding value on AA credits during the first half of 2024, as we insured $2.5 billion of par on 54 deals. We believe that investors see the extra protection of our guarantee as a mitigant of downgrade and market value risk. Non-U.S. public finance produced $34 million of PVP during the first half of 2024, consistent with the $36 million in the first half of 2023. Second quarter activity included primarily secondary market guarantees of several U.K. regulated utility and airport transactions. Our pipeline of potential international public finance transactions includes a significant number that we consider likely to close later in 2024. Global Structured Finance produced $25 million of first half PVP, a solid result. We continue to see opportunities with banks, insurance companies, pension funds, and asset-backed investor clients across sectors, including pooled corporate and fund finance. One additional note about the strength of our second quarter production: our $155 million of second quarter PVP was $64 million higher than that of the second quarter of 2023. In terms of direct PVP production, the second quarter of 2024 was our best second quarter since 2009. We believe we can build on our impressive performance in the first two quarters to complete the year with strong production results. I will now turn the call over to Ben to talk more about our financial results.

Ben Rosenblum, Chief Financial Officer

Thank you, Rob and Dominic, and good morning. I am pleased to report second quarter 2024 adjusted operating income of $80 million, or $1.44 per share, which is more than double the $36 million, or $0.60 per share, reported in the second quarter of 2023. The insurance segment, which contributed $116 million of adjusted operating income in the second quarter of 2024, up from $106 million in the second quarter of 2023, had a few noteworthy items. First, we had no loss expense in the second quarter of 2024, compared with $44 million in the second quarter of 2023. While we did have $21 million of economic loss development in the second quarter of 2024, primarily related to certain healthcare transactions, there was sufficient deferred premium revenue to absorb the development for the quarter, resulting in no loss expense. Second, we had a $10 million increase in equity and earnings, which represents the returns on alternative investments, primarily due to gains in CLO equity tranches and higher invested balances in the second quarter of 2024 compared with the second quarter of 2023. Fair value changes of assets underlying the alternative investment may cause volatility in adjusted operating income from quarter to quarter. However, on an inception-to-date basis, they have generated an annualized internal rate of return of 14% in the insurance segment. These increases were partially offset by lower fair value gains on the Puerto Rico contingent value instruments, which was $17 million in the second quarter of 2024, compared with $40 million in the second quarter of 2023. As of June 30, the fair value of the remaining CVI was $221 million. Our deferred revenue, which represents the storehouse of future earnings in the insurance segment, remained strong at $3.9 billion and is a direct result of the new business production that Rob discussed. For the second quarter of 2023, the Asset Management segment results consisted of Assured IM results as it was still a wholly owned consolidated entity. Since the closing of the Sound Point and AHP transactions in July of 2023, the Asset Management segment primarily includes our equity pickup on the SoundPoint investment, which is on a quarter lag and is reported net of amortization of intangible assets and continuing performance fees on asset-based and healthcare strategies. The second quarter 2024 income from SoundPoint was close to breakeven, which is in line with our seasonally adjusted expectations, as GAAP revenue recognition rules result in SoundPoint's performance fees generally being recognized towards the end of their calendar year. On the capital management front, in the second quarter of 2024, we repurchased 1.9 million shares for $152 million at an average price of $78.50 per share. Stock buybacks continue to be one of our most accretive strategies. Our remaining authorization is approximately $275 million. In terms of the holding company liquidity position, we have cash and investments of approximately $308 million, of which $55 million resides in AGL. The share repurchase program, along with adjusted operating income and new business production, collectively contributed to new records for adjusted operating shareholders' equity per share of over $109 and adjusted book value per share of over $161. While adjusted operating income varies from period to period, the consistent quarterly increases in these book value metrics reflect how the successful execution of all our key strategic initiatives builds shareholder value over the long term. As Dominic mentioned, the AGM and AG merger, along with $400 million of stock redemptions, results in capital efficiencies and demonstrates the continued execution of our key strategic initiatives. About $270 million of the stock redemptions were in cash, while the remainder consisted of alternative investments. These stock redemptions are available for use in corporate initiatives, including share repurchases. I'll now turn the call over to our operator to give you the instructions for the Q&A period.

Operator, Operator

Our first question comes from Tommy McJoynt from KBW. Tommy, your line is open.

Tommy McJoynt, Analyst

Starting off on PREPA. You mentioned and we saw the appeals court ruling in June, can you just walk through the process for how sort of you guys are seeing that information, that court ruling impacts what you guys ultimately book as your sort of loss reserve or recovery around that specific credit in the quarter? I guess we were a little surprised not to see a more favorable mark once that ruling came through?

Dominic Frederico, President and CEO

Well, I'll give you the top and I'll let Ben give you the bottom. So at the top, the ruling is very favorable. And obviously, it's a ruling that we had expected all along as the judge continued to avoid the law or the contract that was signed, so we thought that was going to be the outcome, number one. Number two, there's still a lot of road to hoe relative to appeals. Number three, timing does matter in how you look at your reserving in terms of when the settlements would actually take place. So we did adjust scenarios, but we thought it would be prudent because of the open areas in terms of mediation and appeals in terms of what an ultimate decision will be. So you got to continue to rely on the scenario analysis and probability weightings, and we thought we did the right thing in keeping it consistent while we wait for further information and further activity.

Rob Bailenson, Chief Operating Officer

I would say, Dominic pretty much took all the words out of my mouth; I couldn't have said it any better. I mean, you have scenarios, and a lot of our scenarios assumed that we were going to win. We knew we had a very strong case. And now we just have to see it through, and timing, as we said, does matter.

Tommy McJoynt, Analyst

And then switching topics, switching over to capital; kind of stick with me here as I walk through some numbers. You've done $400 million of special dividend sort of capital releases out of the subs to the holding company already this year. On Slide 16, it looks like the regular way dividend limitation is $483 million combined. So that's together nearly $900 million combined. I know the holding company has about $200 million of cash expenses annually. So that still leaves about $700 million. That's about $200 million in excess of your $500 million annual buyback target. Did you have any plans for what you'll look to do with that extra couple of hundred million dollars of liquidity?

Dominic Frederico, President and CEO

Well, remember, it's a $500 million target per year. And obviously, we'd like to make sure we have enough cash in the foreseeable future to meet that obligation as it comes due. It gives us some flexibility as we hold on to the additional balances just to see something as an accretive opportunity, be it an acquisition, or another business opportunity. But by and large, it's there for share repurchase. And as we said, we've always looked at a $500 million target, so this kind of ensures that 2025 looks pretty good as well.

Tommy McJoynt, Analyst

On the acquisition opportunity front, is there anything that you guys are actively looking at right now?

Dominic Frederico, President and CEO

Other than the remaining monolines, which we've always talked about as an opportunity, but they're really not capital consumptive at this point. So the answer would be no at this point in time for other acquisitions.

Operator, Operator

Our next question comes from Giuliano Bologna from Compass Point. Giuliano, your line is now open.

Giuliano Bologna, Analyst

Congratulations on another great quarter. It sounds like the preference at this point is to kind of extend the runway of the $500 million buyback pace? And then it sounds like—you’re obviously in a very good position for '25. I'm curious how you think about that long term. Obviously, you're in a great position for the next couple of years. Is that the way you'd like to run your capital strategy for the next few years going forward? And do you think at some point it would evolve to more reinvestment into the business? Or how do you think about that longer term?

Dominic Frederico, President and CEO

Well, we'll still continue to evaluate it as the most accretive transaction. So as long as we continue to look at that runway and the runway is positive, we're going to continue to execute on that basis. And this gives us tremendous flexibility as well. We stuck with the $500 million right, wrong or indifferent. We think that's been the best way to apply it. It's provided consistent support for the stock and has allowed the evaluation to continue to increase. We’re near where we expected to be and where we expect it to get to ultimately, but we still think it's the most reliable approach. And like you said, this really does clear the runway for quite a period of time.

Giuliano Bologna, Analyst

And then on the new business front, you obviously had some very good wins on some larger transactions that clearly have some institutional demand. I'm curious if you see any opportunities on the structured side of the business or on the international side, like be accretive and scalable in the near term.

Dominic Frederico, President and CEO

Rob Bailenson is ready to jump out of his chair; I'll let him answer the question.

Rob Bailenson, Chief Operating Officer

Yes. We are seeing a lot of opportunities in structured finance and international infrastructure markets. We closed a number of subscription finance transactions, direct lending pooled corporates, whole business securitizations, transportation and regulated utility sectors. We're seeing this across the U.K., Continental Europe, North America, and Australia. We have put resources, as you know, into Australia, and we're seeing some early successes there in structured finance as well as infrastructure. So we're really excited about those opportunities.

Operator, Operator

Our next question comes from Geoffrey Dunn from Dowling Partners. Geoffrey, your line is now open.

Geoffrey Dunn, Analyst

Can you talk a little bit about the healthcare issues that you're facing? And what's causing some of the pressure on those deals? I know it's modest development we saw this quarter on an economic basis. But what are the pressures there? And more importantly, what are your protections in those deals?

Dominic Frederico, President and CEO

Let me start from the top. So remember, when we look at healthcare, we always look at essential services, major leaders in the marketplace, and provide ourselves with other covenants to protect our position. Obviously, coming through COVID caused a tremendous spike in pricing, both for nursing and supplies; labor costs went through the roof. Other costs increased significantly. I think it's been a while for both the third-party reimbursement to adjust, as well as for the hospitals themselves to adapt. As we've seen in our book of business, things continue to improve. As I said, we have tremendous covenants and protections in place, so we’re still very optimistic about the value of healthcare. We only get paid when problems exist, so we're happy to make sure that the opportunities we see in the market are realized. We typically have mortgages on the properties, liquidity constraints, and debt service reserve covenants. So, as I said, it's a well-protected portfolio. Obviously, the stress has been caused mostly by COVID and inflation, but we see the hospitals now starting to address that, and the results are improving. The protections are quite strong. We still like the business, and we look forward to increasing overall production as well as the return on those individual policies.

Geoffrey Dunn, Analyst

And then the other question I have—I’m not sure you can answer it—but obviously, the company's ROE is diluted with all the excess capital that you're sitting on. Can you give a range as to what the underlying operating ROE looks like if you were running efficiently?

Dominic Frederico, President and CEO

No, we have a target that we got to get to double digits in every business that we write relative to the overall business written by each of the profit center sides: structured, international, and domestic public finance. So that's still the goal. What's affecting us is obviously the excess capital that we carry, which has principally been in response to the problems in the past: the Great Recession, the pandemic, and Puerto Rico. As those issues now dissipate, it’s a big challenge for the company; how much of the excess capital we want to keep for safety versus reducing it to an optimal level. But as you know, with the statutory limitations we have, it will take some years to arrive at that level. We have a plan to achieve this over the near term. We're confident in the growth of the business and in further diversification, through ventures like asset management, we’ll be able to increase the operating return. As I said, the excess capital must come down based on the schedule we established for capital management, although it may not decrease as quickly as we’d like. If I told you what the excess capital was, it's effectively the same amount we had back in 2013 when we began the buyback, and even after buying back $5.2 billion of stock, we're still at the same point of excess capital, which is both a good and a bad situation. But it does impact the ROE, and we’re still working to ensure we can reduce that excess capital meaningfully.

Rob Bailenson, Chief Operating Officer

And Geoffrey, as Dominick said, as we expand nationally in structured finance and international infrastructure, those ROEs are mid-teens or even higher. So as we grow those sectors, it really contributes positively to the operating return.

Geoffrey Dunn, Analyst

So is it fair to say that this is more to the business than 10 to 12?

Dominic Frederico, President and CEO

The international side could be even higher, yes, exactly.

Rob Bailenson, Chief Operating Officer

It depends on the mix.

Dominic Frederico, President and CEO

We earn very little premium. Remember, we take long lead times on earning premium. When you think about each year's business, it contributes about 8% to the bottom line; it takes a while to see meaningful changes. But as we see production building, that will help tremendously two or three years out.

Geoffrey Dunn, Analyst

And I guess just a follow-up. Your comment about the capital being the same, the excess capital, the same as 2013, it’s a little ironic with how much you return; you’re sprinting just to stay still here. How do you get ahead of that because you're...

Dominic Frederico, President and CEO

A significant problem. Remember, the reason we're at the same point is really due to unique opportunities that we capitalized on, buying all the competitors at substantial discounts to the capital valuation and executing large reinsurance deals, refinancing, or restructuring our capital base and mergers, eliminating other companies. So we've had these unique transactions that have really accelerated earnings during the refunding wave. Now we see that this kind of unique accelerations have moderated, and we’re more focused on core earnings growth. We're now very confident that we can make a real impact on the capital over the next few years. Our projections support this view.

Operator, Operator

This concludes the question-and-answer session. I would like to turn the conference back to our host, Robert Tucker for closing remarks. Please go ahead.

Robert Tucker, Senior Managing Director, Investor Relations and Corporate Communications

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.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you all for attending. You may now disconnect your lines. Have a great day.