Earnings Call Transcript - AGO Q2 2022

Operator, Operator

Good morning, and welcome to the Assured Guaranty Ltd. Second Quarter 2022 Earnings Conference Call. My name is Danielle and I will be the operator for today’s call. 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.

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 2022 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 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, 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.

Dominic Frederico, President and CEO

Thank you, Robert, and welcome to our earnings call today. At the halfway mark of 2022, Assured Guaranty’s adjusted operating shareholders’ equity per share and adjusted book value per share were at the highest levels in our history, $90.18 and $134.91 respectively. The second quarter and first half of 2022 were marked by extreme market volatility, rapidly increasing inflation, and Fed action to raise interest rates. Rob will cover how the shifting interest rate environment affected our financial results, but I am pleased to say that our core insurance business continues to perform well in this year’s volatile markets. New business production has been strong and consistent with recent years’ excellent results. The first half of 2022 PVP totaled $145 million, and its sources were diversified across U.S. public finance, international infrastructure, and global structured finance. In terms of direct PVP, we again produced more than $100 million of first half direct PVP, making it 5 out of the last 6 years that we’ve exceeded that milestone. In U.S. public finance during the same period, this year’s $106 million first half direct PVP was second only to last year’s first half production and would have easily been the best first half of any year with the inclusion of one of our large transactions that sold in the second quarter or closed in the third quarter. In the first half of 2022, municipal bond yields trended higher and credit spreads also widened, though to a lesser extent. The June 30 benchmark yield of 3.18% for a 30-year AAA GO bonds reflected a 65 basis point increase in the second quarter alone and was more than double the yield at the start of the year. However, yields and spreads were unusually volatile. New money issues rose modestly in par volume and dominated the market while rising interest rates also pushed potential refunding, including taxable advance refundings out of the money, causing overall market volumes to decline. We continue to see high demand for our bond insurance compared with pre-pandemic levels. The first half of 2022 insured penetration of 8.8% was higher than the 8.4% in the first half of 2021 and significantly higher than the 5.9% in 2019’s first half. We believe that two important factors have helped to amplify the use of bond insurance: wider investor awareness and insurance offering safety amid the potential consequences of volatile economic conditions, and a larger number of issuers recognizing the cost-effectiveness of bond insurance. For the first half of 2022, Assured’s share of the insured primary municipal bond market exceeded 56%. We guaranteed 380 new issues with a total of $10 billion in insured par sold. We set a 12-year record for first half secondary market par written at almost $1.8 billion, and combined primary and secondary market insured par sold at $11.8 billion. Our direct gross par written on U.S. municipal transactions closed during the first half was also the highest in 12 years. Contributing to this were 17 prime market transactions where we guaranteed $100 million or more of par each. We believe deals of this size reflect significant institutional demand for our insurance due to the financial strength of our guarantee and the relative price stability and increased market liquidity our insurance can provide. Looking at the second quarter, our insurance par sold totaled $6.5 billion, of which $1.4 billion was secondary market par. Total insurance penetration for the quarter was 8.9%. Our bond insurance market share was over 54%. We also guaranteed 10 large transactions sold in the quarter that utilized over $100 million of our insurance each. These included a $608 million New York Power Authority issue, entirely wrapped by Assured Guaranty, and a $468 million portion of an Alameda Corridor Transportation Authority issue, which closed after the quarter end and contributed to the strong start we’ve seen for our third quarter PVP results. In fact, across our company in the week since the third quarter began, we have already written more than $75 million of PVP. Remember, our first half total PVP was $145 million. As signs and investors recognize the strength of our guarantee, we continue to add value on AA credits. For the first half of 2022, we insured $1.6 billion of par sold through 79 primary and secondary market policies on bonds rated in the AA category by S&P or Moody’s or both. This included $1.1 billion of par on 52 deals sold in the second quarter, of which approximately $300 million was insured in the secondary market. International Public Finance produced $30 million of PVP during the first half of 2022, including $18 million in the second quarter. In May, we wrote a large secondary market guarantee for an institutional investor. Our pipeline of potential international public finance transactions looks very good and includes a number of significant transactions that we consider likely to close in 2022. As I said previously, we have already seen a strong start in the third quarter. In Global Structured Finance, we continue to see potential opportunities with clients such as life insurers, banks, other direct lenders, pension funds, and asset-backed investors. We closed our second guarantee of the subscription finding facility for a bank during the second quarter and see many opportunities to work with new counterparties in the fund finance sector. The CLO market remains an important area of focus, and we are speaking with current and potential CLO investors about opportunities created by the recent spread widening. More importantly, our insured portfolio quality continues to improve. During the first 6 months of this year, our exposure to below investment-grade credits decreased by almost $2 billion of par, including the $1.3 billion of Puerto Rico exposure we extinguished as a result of the Commonwealth’s GO PBA plan of adjustment. Our BIG par exposure now represents only 2.3% of our insured portfolio. On our last call, I mentioned that as part of the Commonwealth’s GO PBA plan of adjustment, we received cash and new GO bonds totaling approximately $1.2 billion, plus additional contingent value instruments. Additionally, concerning the Highways and Transportation Authority revenue bonds, in July, we received from the Commonwealth pursuant to the Commonwealth GO PBA plan of adjustment, $147 million of cash and $668 million notional of contingent value instrument. The HTA plan of adjustment confirmation hearing has been set for August 17 and 18. Assuming the current HTA plan is confirmed and implemented, we expect to receive additional recoveries in the fourth quarter. Virtually all responsible parties understand that completing the island’s debt restructuring is a key factor for its further economic progress in Puerto Rico. There is recourse applying pressure to complete mediation to achieve a consensual resolution of the treatment of the Puerto Rico Electric Power Authority revenue bonds, our last unresolved Puerto Rico exposure. On July 29, the judge extended the term of the mediation to August 15. The improved quality of our already high-quality insured portfolio adds to the reasons for our insurance subsidiaries' high financial strength rating. S&P has recently affirmed its AA financial strength rating for all of our financial guaranteed companies, citing both our very strong financial risk profile and very strong business risk profile in its annual review of Assured Guaranty. This report describes many strengths supporting our AA rating, including S&P’s view that we have excellent capital and earnings with a meaningful capital adequacy buffer. You can read the entire report on our website, assuredguaranty.com. On the asset management side of our business, during the second quarter, we increased assets under management by approximately $950 million to $17.9 billion, of which 96% is now fee earnings. Third-party inflows totaled $1.3 billion. We closed a new CLO and held an oversubscribed final closing for our latest health care fund, and we continue to execute our other strategic objectives. Given the uncertainty in this economic environment, it’s good to reflect on the proven resiliency of our company. In the first year of the pandemic, we saw investor appetite for bond insurance increase, and that heightened interest has been maintained, as this year’s developments continue to remind investors that the future is often volatile. We have succeeded through decades of economic cycles by delivering on our commitments to protect investors’ principal and interest against all risks while proving our resilience through disciplined risk management and responsible stewardship of capital. Our insurance subsidiaries' aggregate $11 billion of claim-paying resources today, approximately the same as they were at the end of 2007. Even though since then, we have paid gross claims exceeding $13 billion to keep investors whole and returning $5 billion to shareholders through share buybacks and dividends. We maintain those numbers by mitigating losses on gross claim payments for only $6 billion of net claims through recoveries, reinsurance, and reimbursement, and by earning more than $6 billion in adjusted operating income over the same period. Our $11 billion of claim-paying resources now supports a much smaller and higher quality portfolio of insured risk. By every measurement that compares our capital resources to insured exposure, our insured leverage is less than half of what it was at the end of 2009. This resilience has positioned us to thrive as business and market conditions create more incentives for the use of financial guarantees. We have never been better prepared to serve our clients, protect our policyholders, and create value for our shareholders. I will now turn the call over to Rob.

Rob Bailenson, Chief Financial Officer

Thank you, Dominic, and good morning to everyone on the call. In the second quarter of 2022, adjusted operating income was $30 million or $0.46 per share compared with $120 million or $1.59 per share in the second quarter of 2021. The largest drivers of the quarter-over-quarter variance are mark-to-market movements on alternative investments, which had a $27 million after-tax loss in the second quarter of 2022 versus a $38 million after-tax gain in the second quarter of last year, and the trading portfolio, which consists of Puerto Rico contingent value instruments, and that experienced a $15 million loss in the second quarter of 2022. Our core underwriting results, excluding these fair value adjustments, remain strong. As I mentioned in the past, quarter-to-quarter comparisons of adjusted operating income are volatile due to the nature of these investments and the corresponding accounting that requires recognition of these mark-to-market movements in income. However, it’s important to note that for the Assured IM funds, which account for most of this variance, the inception-to-date mark is a pretax gain of $98 million. This represents a 10.8% total return, which is in line with our targeted return, demonstrating the value of our investment diversification strategy into alternative investments. As for the Puerto Rico CVI or contingent value instruments, the company received these instruments as part of the March 2022 resolution of the GO PBA exposures, which resulted in a $1.3 billion reduction of our insured exposure to Puerto Rico. We now manage this component of our Puerto Rico exposure as tradable instruments. Any gains and losses we recognized in adjusted operating income on this portfolio are a reflection of current market pricing. Both mark-to-market adjustments, which account for $80 million of the variance, are reflected in the insurance segment, which had adjusted operating income of $55 million in the second quarter of 2022 compared with $152 million in the prior year. Insurance segment net earned premiums and credit derivative revenues were $86 million in the second quarter of 2022 compared with $106 million in the same period of last year. The refunding component of earned premiums, as well as changes in debt service assumptions, accounted for the majority of the change. Economic development on our BIG insured portfolio was a benefit of $32 million, primarily consisting of a $39 million benefit in U.S. RMBS. Included in total economic development is the effect of increasing discount rates, which was a benefit of $42 million in the second quarter of 2022 across all sectors. This resulted in a benefit in loss expense of $17 million, which is a function of both economic development and amortization of deferred premium revenue. For the Insurance segment, income from the investment portfolio consists of several components: net investment income on the available sale portfolio and changes in the fair value of trading securities and alternative investments. Net investment income was $66 million in the second quarter of 2022 compared with $71 million in the second quarter of 2021, primarily due to lower average balances. Equity and earnings on alternative investments was a net loss of $34 million in the second quarter of 2022. The losses were a result of lower net asset values of the CLO funds and dilution from rebalancing following a funnel fundraising close for the health care fund. In the second quarter of last year, these funds had gains of $48 million. This volatility was the single largest driver of the quarter-over-quarter period variance in adjusted operating income. Fair value losses on the trading portfolio were $18 million, which represents mark-to-market movements on the Puerto Rico contingent value issuance. The Asset Management segment's adjusted operating income increased to breakeven in the second quarter of 2022. With respect to our capital management objectives, we repurchased 2.6 million shares for $151 million in the second quarter of 2022. Subsequent to the quarter close, we repurchased over 600,000 shares for $35 million. On August 3, 2022, the Board of Directors authorized the repurchase of an additional $250 million of our common shares, which brings our current remaining authorization to $365 million. Continued share repurchases, along with our positive adjusted operating income and new business production, have propelled operating shareholders’ equity and adjusted book value per share to new records of over $90 and $134, respectively. Since the beginning of our repurchase program in 2013, we have returned $4.5 billion to shareholders, resulting in a 71% reduction in total shares outstanding. From a liquidity standpoint, the holding companies currently have cash and investments of approximately $189 million, of which $135 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. As we look forward to the rest of the year, we remain optimistic that the interest rate environment will be more conducive to new insurance business production. The Asset Management segment and alternative asset strategies will continue to contribute to the company’s progress towards its long-term strategic goals. In Puerto Rico, our largest single below investment-grade exposure will be substantially resolved by the end of the year. In a sign of continued progress, we received $147 million in cash and $668 million in original notional contingent value instruments in July as part of the pending HTA settlement.

Operator, Operator

We will take our first question. Your line is open.

Unidentified Analyst, Analyst

Hey, good morning. Thanks for taking my questions here. Could you go into a bit more detail on the earned premium declines? I think you attributed it somewhat to a change in debt service assumptions. What does that mean for the go-forward recognition of premiums and what you expect there?

Rob Bailenson, Chief Financial Officer

Half of it was due to a decline in refundings and the other part was an extension of the life of a transaction because it’s CPI related in the UK. When you have a significant amount of premium associated with that, you have to reallocate that, and it’s more exposure. If you have more exposure, then you have to earn it over a longer period of time, which then slows down your expected earned premium.

Dominic Frederico, President and CEO

So it doesn’t make it smaller. It just makes it go over a longer period of time.

Unidentified Analyst, Analyst

Okay, got it. And then it sounds like your demand for your wrap remains strong. Can you talk about pricing on new business relative to the in-force book, both from a pricing power perspective as well as considering a more uncertain economic outlook?

Dominic Frederico, President and CEO

Well, as you know, we get paid on debt service, which means as interest rates go up, that service increases. Therefore, the premium calculation of rate time that service becomes higher. Typically, as interest rates go up, spreads widen; we get paid based on the percentage of spread, which becomes an even more favorable market for us regarding ultimate return. We calculate return on a transaction-by-transaction basis and then compare it across quarters and years. Our goal is always to get a double-digit return. Obviously, there is volatility in that as sometimes a larger transaction might come in higher or lower on the basis, and it’s because we give a certain amount per quarter that could fluctuate the results. At the end of the day, we are hitting our target in terms of return. We think the market will continue to get better for us as the year progresses. The first half of the year has been volatile. There has been a bit of sticker shock regarding the issuance in the marketplace. New money is up a bit, but there is virtually little activity on the refunding side. However, this environment creates an even better situation for secondary market transactions. To give you a statistic, we are winning as much business in the first 6 months in the secondary market as we wrote in all of last year. In the secondary market, it’s obviously higher priced, higher return business. The more that that complements direct primary business really drives ROEs up to very reasonable or profitable levels for the company.

Rob Bailenson, Chief Financial Officer

In the second quarter, we wrote $27 million of PVP. For the 6 months, it was $50 million of PVP, and that’s over $1.4 billion at par for the quarter and $1.7 billion at par for 6 months.

Unidentified Analyst, Analyst

Okay. Good. Helpful numbers. And just lastly, could you remind us what your latest calculation is for how much excess capital you currently have and whether that is looking at perhaps rating agency levels or above an acceptable leverage of CPR to gross par or anything else that you think is relevant?

Dominic Frederico, President and CEO

We look at it from two bases, right? One, rating agencies, because it’s important that we maintain our AA rating from S&P, and then two, our internal capital models to ensure we continue to provide the necessary protection and buffer relative to the marketplace to ensure the company remains financially strong. Obviously, it’s getting a little easier for us as the portfolio continues to amortize down, hence the leverage ratio decreases. The excess capital position has remained relatively significant. The only number we have given you from 2019 is over $2 billion, and we still maintain a significant level of excess capital. In our capital management strategy, the majority has obviously been positioned relative to share buybacks, which we will continue as part of our strategy. We will continue to evaluate circumstances as the market evolves, and as the portfolio amortizes, the higher risk continues to decline. Thus, that excess capital position is still significant. Remember, that’s after returning $4 billion of capital to shareholders. We’ve still got a long way to go relative to working the capital down to a reasonable level that could provide us the opportunity for higher ROEs and improve the company’s valuation. We look forward with strong optimism that the financial guarantee business is growing, and its profitability is widening, which should contribute to higher earned premiums over the next few years. We are still managing the capital balance. We finally stabilized the asset management side and have started to build the verticals and see profitability from that operation. If you look at all three combined, I think it puts us in a very good position relative to improving ROE against the lower capital base with the two lines of business functioning very well in this marketplace.

Unidentified Analyst, Analyst

Great. Thank you.

Rob Bailenson, Chief Financial Officer

Thanks, Tommy.

Operator, Operator

We will take our next question from the line of Geoffrey Dunn with Dowling & Partners. Please go ahead. Your line is now open.

Geoffrey Dunn, Analyst

Thanks. Good morning, guys.

Rob Bailenson, Chief Financial Officer

Hi, Geoff.

Dominic Frederico, President and CEO

Hi, Geoff.

Geoffrey Dunn, Analyst

Rob, I wanted to understand how the new mark on trading securities, I believe that applies to the CVIs you received. But that is a mark, if I understand correctly, that has occurred since you received those CVIs on July 8 or does that extend back to some of the instruments you received on the GOs as well?

Rob Bailenson, Chief Financial Officer

Yes, it extends back to when we received the original CVIs.

Geoffrey Dunn, Analyst

Okay. So, but it includes some of the HTA stuff, too or no?

Rob Bailenson, Chief Financial Officer

The HTA stuff came in very late. So the mark-to-market movement is primarily related to that and general obligations, not initiated.

Geoffrey Dunn, Analyst

Okay. So what I wanted to understand is with the mark-to-market noise and obviously, it’s going to bounce around each quarter, does that affect your recovery assumptions on CVIs to be received in the future with respect to your reserving at all, or is it truly just marked noise that doesn’t have any implications on the core reserve position?

Dominic Frederico, President and CEO

If you remember, Geoff, we book a recovery estimate. Once you physically receive the instruments of the recovery, they get priced on the day of receipt, setting the recovery period relative to the insurance policy. It now becomes an investment in the investment portfolio, now subject to any volatility in terms of pricing in that portfolio until you either hold them to maturity or sell them.

Rob Bailenson, Chief Financial Officer

Yes. We have already locked in what’s going to be in our reserve, and now it’s actually going to flow through that investment portfolio.

Geoffrey Dunn, Analyst

That I understand. I’m just wondering if the trading securities you now have in any way influence your recovery expectation on the CVI still to be received in the future?

Dominic Frederico, President and CEO

Not for the insurance policy, but now for the investment return, right? You have to make sure you understand that at the date of the settlement that locks in the recovery related to the insurance policy. Now it’s no longer having anything to do with recovery on insurance, what the ultimate claim was and now becomes an investment. Obviously, we will continue to evaluate market conditions, expectations of shareholder returns, and market returns. Therefore, we will manage that balance accordingly as we go through the period.

Rob Bailenson, Chief Financial Officer

And, Geoff, we have already received. Maybe this will help – we have already received all of the CVIs that we were going to get from the GOs and the transportation. So, we do not expect anymore. Therefore, it will not affect any reserve assumptions.

Geoffrey Dunn, Analyst

Okay. So, on the HTA, then, all that’s remaining is new bonds, or is there a cash and new bond component still to come?

Rob Bailenson, Chief Financial Officer

As the cash and new bonds are coming when the plan is approved.

Geoffrey Dunn, Analyst

Got it. Okay, great. Thank you.

Operator, Operator

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

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

Thank you, operator, and thank you all 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

This concludes today’s conference call. Thank you for attending. You may now disconnect your lines. Have a great day.