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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Assured Guaranty Third Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Mr. Robert Tucker, Senior Managing Director, Investor Relations and Communications. Please go ahead, sir.
Thank you, operator. And thank you all for joining Assured Guaranty for our third quarter 2019 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 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.
This presentation also includes references to non-GAAP financial measures. We present the GAAP financial measures, most directly comparable with the non-GAAP financial measures referenced in this presentation, along with a reconciliation between such GAAP and non-GAAP financial measures and 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'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. The third quarter of 2019 was Assured Guaranty’s best third quarter for new business production since 2010 with $81 million of PVP. During the quarter, we also continued our capital management program and Rob will provide you the details on that shortly.
We also focused on completing the acquisition of BlueMountain Capital Management, which we closed on October the 1. This strategic accomplishment provides revenue diversification, mitigates enterprise risk to the generation of fee income and further advances our capital management objectives by deploying [indiscernible] capital in higher return investments.
The strong new business result was well supported by all three of our financial guaranty businesses, US public finance, international infrastructure finance and global structured finance, reflecting the advantages of our diversified financial guaranty business strategy.
The largest portion of the third quarter PVP came from US public finance with $46 million of PVP, US finance production was up 39% from third quarter 2018 PVP. With the help of the largest insured public finance transaction since 2010, a $700 million in short taxable portion of a $6.5 billion health care issue for Common Spirit Health, which is the bond buyer’s 2019 health care deal of the year.
Including that transaction in addition to six other municipal bonds in which we guaranteed $100 million or more of principal, our primary market bond insurance sold was 61% higher in this year’s third quarter than in the last year.
Our competitive advantage ensuring larger transactions and those in specialized sectors such as health care, along with our broad acceptance by institutional investors help us maintain our leading position with a 58% share of the primary municipal bond insurance market.
While market conditions served to constrain bond insurers ability to drive savings on certain transactions, insurance penetration still moved to 5.7% for the third quarter from 5.1% in the prior year third quarter, as total insured par grew faster than total market issuance.
Year to-date versus the same period last year, industry insured par volume has also increased at a higher rate than the market as a whole and the growth in Assured Guaranty's insured volume outpaced the industry's growth.
Given the low rate and tight spread environment, we attribute the superior performance to greater awareness and appreciation of Assured Guaranty's value proposition and part of both institutional and individual investments.
While we are the leading financial guaranty insurance company in US public finance, we’re the only one serving and cultivating new opportunities in the international and structured finance markets. This diversification allows us to exploit favorable opportunities in multiple markets.
We have now generated international PVP in 16 consecutive quarters even though many of our structured transactions have long development times, which make our timing of closing uncertain. With several years of consistent performance under our belt, it is clear the value of our financial guaranty thus is firmly re-established outside the United States.
Recently in preparation for Brexit, we established a new French subsidiary Assured Guaranty Europe which will allow us to pursue new business in the continent more easily, and if the United Kingdom is no longer part of the European Union provides us a platform on the continent.
In our global structured finance business, we executed a commitment to ensure a $420 million life insurance reserve financing transaction for a major US insurance company during the third quarter. We also continue to ramp asset-backed securities in the secondary markets to further establish our trading value in that important market.
Additionally, we continue to pursue opportunities in the aviation sector including residual value transactions through our specialty insurance subsidiary, Assured Guaranty Re Overseas Limited, which saw its a-plus rating from A.M. Best reaffirmed in July.
In addition to producing strong originations during the quarter, we are very optimistic about the financial guaranty business we will complete by the end of the year. So far in the fourth quarter, we have added more than $70 million of PVP that includes premiums from £195 million transaction for the Glassgow City Council and a $500 million insurance company reserve transaction and a $362 million of insured bonds for the New York State Thruway Authority and we have additional significant transactions in the pipeline for year end 2019.
On another positive note, S&P affirmed its AA rating on our financial guaranty subsidiaries with a stable outlook based on the revised bond insurance rating methodology released in July. Regarding Puerto Rico, the actual financial picture continues to improve.
Lastly, Puerto Rico [Technical Difficulty] bank account balances for the government and certain public corporations had totaled $16.4 billion, up from $15.5 billion a month earlier. The September 30 total includes $8.3 billion of the Commonwealth main operating bank account loan, the treasury single account, far more than enough to cover the current annual contractual debt service of $1.8 billion, including the general obligation that Puerto Rico's constitution says must be paid before any other expenses [ph]
Last month, the US Supreme Court [indiscernible] a lower court ruling that bond holders have a [Technical Difficulty] local government revenues contribute to the Puerto Rico's pension system. We consider this an important development even though we are not among the pension bond holders because it upholds the rural law and respect for contractual liens in Puerto Rico, something the Oversight Board has continue to ignore in all of its proposals.
It was encouraging last month here the Executive Director of the Oversight Board testified to [Technical Difficulty] risk of being removed from the scene will likely not provide Puerto Rico in the future with access to funds that are definitely going to be needed to continue to invest in the capital infrastructure of the Island and so not only the bondholder themselves but future investments in the Island, both equity and debt will take note and be fearful of investing into an environment like that.
She was making the same point that we and other market participants have been making all along. Laws and rights cannot be ignored. And if you try, the consequence will make future borrowing difficult, if not, impossible.
Acknowledging that reality, we are hopeful that the recently sworn in Governor, Wanda Vazquez will support solution to the Island's financial troubles and ensure the Island has limited access to the capital markets and a positive economic growth that is produced by associated new capital investment.
The governor's support of the Puerto Rico Electric Power Authority's restructuring [Technical Difficulty] is critical to transforming and modernizing electrical system on the island to enhance economic growth. While she is taking a less combative stance with the Board than her predecessor, she also appears to want to rational consensually agreed resolution that restores the Island's financial credibility and economic stability, and get some of the work on rebuilding Puerto Rico. We look forward to working with her to achieve these goals.
Hopefully, this will leave us with a better plan of adjustment than the proposed plan the Oversight Board has filed. In our view the proposed plan is premised on a number of terms that Assured Guaranty believes violates Puerto Rico law, its constitution and permissive [ph]. It ignores constitutionally supported liens and priorities and was developed in the absence of consensual discussions with the Island's long-term and largest creditors.
At its core, it's based on a plan support agreement in which creditors signatories generally purchased their bonds at deep discounts and represent only a small fraction of the outstanding debt and plans [Technical Difficulty] how investors should think of Assured Guaranty Limited as we move forward.
Now that we have completed our acquisition of BlueMountain, it is hard to overstate the transformational nature of this transaction [Technical Difficulty] leading provider of financial guaranty's in the US and the international public finance and structured finance markets.
Now in addition we're a provider of alternative asset management services for institutional and other qualified investors. At the acquisition date, we had $18.2 billion in assets under management over the 18 largest global manager of [indiscernible].
With this acquisition, we're positioned to significantly diversify our revenue sources [Technical Difficulty] to lower risk associated with overall income generation. Revenues from the financial guaranty business come from risk based premiums that required an incremental allocation of capital with each transaction.
In contrast [Technical Difficulty] management are fee-based and the scope of our investment is largely limited to the purchase price and working capital we have already committed or intend to commit. Both of the segments rely on the deep credit expertise that is the hallmark of Assured Guaranty and the talent, experience and business relations by each segment going to potentially powerful synergies that can strengthen our company for the long-term.
[Technical Difficulty] we also expect [Technical Difficulty] assets related to some of our excess capital of our operating subsidiaries that get up the dividend now for capital management.
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 that non-GAAP operating shareholders equity and adjusted book value per share increased to new record highs of $64.48 and $90.18 respectively.
Non-GAAP operating income in the third quarter of 2019 was $77 million or $0.79 per share compared with $161 million or $1.47 per share in the third quarter of 2018. Operating income in the third quarter of 2018 benefited from a non-recurring $31 million gain on our investment in TMC Bonds Inc. and a lower effective tax rate. Operating income in the third quarter of 2019 at lower net earned premiums and higher loss expense.
Net earned premiums were $123 million in the third quarter of 2019, compared with $142 million in the third quarter of 2018. Net earned premiums in the quarter are consistent with the portfolio amortization schedule.
Accelerations due to refundings and terminations of $37 million in third quarter 2019, compared with $40 million in the third quarter of 2018. Third quarter 2019 loss expense was $40 million compared with $18 million in third quarter of 2018. In both periods, the expense was primarily related to economic loss development on certain Puerto Rico exposures, offset by an economic benefit related to US RMBS.
Net economic loss development in the third quarter of 2019 were $25 million. This included $55 million in loss development on public finance exposures mainly attributable to Puerto Rico, which was partially offset by a $30 million benefit by structured finance transactions, mainly from RMBS exposures.
First lien US RMBS experienced a benefit of $27 million, driven by higher excess spread due to lower LIBOR rates. The economic benefit in the second lien RMBS transactions was $30 million and was primarily attributable to improved performance of the underlying collateral. The effective changes in discount rates on economic development was not material for the third quarter of 2019.
As a reminder, loss expense reported in operating income in any given period differs from economic loss development due to the consideration of unearned premium reserve in the calculation of loss and LAE under GAAP accounting rules, as well as the inclusion of economic development related to FG VIEs in economic development.
The effective tax rate in the third quarter of 2019 was 16% compared with 7% in the third quarter of 2018. The effective tax rate fluctuates from period to period, based on the proportion of incomes in different tax jurisdictions.
In terms of strategic initiatives, we have continued to repurchase shares in order to efficiently manage our capital position. During the third quarter of 2019, we repurchased 3.4 million shares for $150 million at an average price of $44.11 per share, bringing our cumulative repurchases since the beginning of 2013, and through the end of the third quarter to 102 million shares. This represents 53% of the shares that were outstanding at the start of the program.
The cumulative effect of these repurchases was the benefit of approximately $17.69 per share in operating shareholder’s equity and approximately $30.86 in adjusted book value per share.
Since the end of the quarter, we have repurchased an additional 1.3 million shares at an average price of $45.98 for a total of approximately $59 million, bringing the current year-to-date share repurchases to approximately $399 million or 9.1 million shares.
We currently have approximately $308 million in cash and investments at the holding company. We have remaining authorization to purchase $209 million in common shares and expect to achieve our goal of $500 million in share repurchases this year.
Over the coming months we will be continuing to work on integrating BlueMountain's operation. The BlueMountain acquisition represents a significant step in reversing diversifying our revenue streams and enhancing investment returns. We plan to make our first investment in BlueMountain by the end of the year.
I’ll now turn the call over to our operator to give instructions for the Q&A period. Thank you.
Yes, thank you. We will now begin the question and answer session. [Operator Instructions] And the first question comes from Bose George with KBW.
Hey, guys. This is Tommy McJoynt on for Bose.
Hi, Tom.
Hey, guys. I just wanted to ask, what sort of assumptions are changed I guess related to Puerto Rico this - during the quarter, whether it was expectation on timing of recoveries or $1 size of any recoveries, were there any changes during the quarter?
So we just - we look at the plan of adjustment, we saw - when we look at that plan of adjustment, we look at the assumptions in the plan of adjustment and we consider that to be new information and based on that new information, we adjusted one of our scenarios.
Okay. And then switching over to investment income, I understand last quarter you guys had the $14 million benefit, is, what happened, is this quarter more of a good run rate number? And then how do you think about kind of Andrew coming on board and how that could change your approach to kind of positioning the portfolio and what that could do for asset yields?
Well, as you know, we have the benefit of the revised S&P guidelines related to the capital charges on invested assets. That brings us in line with the P&C and led to substantially lowered capital charges for assets rated below A. At the same time, we have been to buy BlueMountain and bring on Andrew and his qualified team of investment professionals. So, it's the perfect opportunity for us to take a look at the mix of assets in the portfolio, understanding the new capital requirements, because obviously we want to protect our ratings and continue to have the excess capital available for us to continue to pack [ph] capital management program.
So, as we speak, the two plans are coming together and we will look at diversifying the portfolio to look for higher yield, but on risk base evaluation to increase returns, remember since these assets are owned by the insurance companies, increasing the returns of those assets increases the investment income in the insurance operation which then increases the dividend capacity which further supports the capital management.
So I think it's a perfect opportunity at the perfect time with a perfect transaction that's going to allow us that flexibility. So we're looking and staging the commitment of assets into the asset management business for diversification of investment alternatives, but with the idea of enhancing yields, while at the same time protecting risk and protecting the capital and the ratings of the company, we expect a good significant yield improvement from this new process.
And just, I want to also mention that we were keeping our balances relatively short because we had to prepare for the purchase of BlueMountain. So the investment income for this quarter was slightly lower than what I would expect - as Andrew put money to work and optimizes the portfolio, I expect that number to rise.
Okay. It makes sense. And then just last one on BlueMountain, there was a news that the hedge fund there was closed in October. Was that planned or there was that kind of expected and I know the focus is definitely more on being a largest CLO manager, but how much do you think that earnings decline without the hedge fund?
Well, I think that hedge fund for us was not strategic and obviously as you can appreciate the market [Technical Difficulty] overall having an issue relative to hedge fund strategy. We think there is specific dedication to core investment philosophies around certain asset classes to which BlueMountain has been historically very, very successful in [Technical Difficulty] find money and energy.
And I think will ultimately result in a better overall result, both for the asset management side in terms of fee generation as well as the return side for the assets that we commit to those specific strategies.
So we look at it today, it's very focused on three core strategies that they had great success in and long track record of basically preferred or performing [Technical Difficulty] for us going forward.
Okay. Thanks guys.
You're welcome.
Thank you. And the next question comes from Ron Bobman with Capital Returns.
Hi, good morning.
Hey, Ron.
Dominic during all your prepared remarks and a little bit in the Q&A, the static is really horrible.
It's the great island of Bermuda's satellite telecommunication capabilities.
Yeah, you might want to say after class and rerecord your portion. But on the substantive side, I had a question about BlueMountain and a little bit of, sort of, is there a seasonality element? Are there any sort of incentive fees that are part of it's - it's income stream? I'll start off with that and see if it warrants any follow up.
Yeah, this is Andrew Feldstein. Hi, Rob. Thanks for the question. There typically are some incentive fees, which are somewhat seasonal and cyclical in terms of their cash receipts. They are accrued as we go if they are expected to be paid in the year in which we are accruing them.
Consistent with what Dominic said earlier, our focus going forward will be on investment vehicles, which have less incentive fees than vehicles that we've managed in the past.
So of the three strategies that Dominic referred to, one of the three will have substantial incentive fees and the incentive fees will be generally long dated and back ended. So wouldn't expect to see that in the - in the early stages of funds wide but rather as time passes.
So over the short term Ron, we expect that with the strategies we're deploying, and as I said that historically plays back to the strength of BlueMountain, we’re really focusing on management fees, because that's our repeatable, recurring solid income that really allows us to pay - make money in the management company, while it also still allows us to have higher returns in the investment portfolio, because of the fact that the performance fees are typically back end loaded.
That's a strategy for the future, not for the current as we look to really build fee income and assets under management in the short term and as we said, we continue to roll out a platform and further diversify its abilities. Those things would [Technical Difficulty] more of a prior strategy, but down the road, as I said, we really want to focus on the fee income and asset management.
And just to make it crystal clear from Andrew's comments, Q1 of 2020, we shouldn't see a hope for, but we shouldn't see a bump in reported income from his business because it's generally been accrued during the course of the year?
No, so even for GAAP purposes, we’re not going to accrue performance fees as part of GAAP income. So to the extent we have it that will be as Andrew says you will accrue it in the year that you're going to get paid it. So there is no expectation building up in the financial team [indiscernible] we could get reversed because of some change in market conditions or some market correction.
That's why, as I said, we’re looking more at the management fee side of the business that fees that are recurring, contracted and continue to apply every quarter, quarter-to-quarter regardless of performance. As we look at performance opportunities, they are longer term, we have one strategy that does utilize that.
But as I said, we're on a GAAP basis, taking the conservative approach and not recognizing accruals for those. We’ll probably give you that parenthetically as just the disclosure item, but it will not be in the GAAP financial statements.
Okay. And so is there any guidance for what may be crystallized at the end of this calendar year that could be reported either it's in Q1 of 2020 or Q4 of '19, as a result of BlueMountain's performance year-to-date '19?
Well, as I said, so if you think about BlueMountain in two pieces, right. One, the remainder of 2019, where we have a lot of the - what I'll call acquisition transaction expenses and some other items in the running, obviously the run-off or write-down of the hedge fund, et cetera. so you will have a lot of noise in the fourth quarter relative to the asset management business.
As you look at 2020, it's really going to be how much assets under management, how much fee income we can generate against fee expenses and what kind of profitability.
And as I said, we expect the ongoing operations to be profitable and accretive to the overall Assured Guaranty.
Okay. Thanks. That's it for me.
Thank you. And the next question comes from Giuliano Bologna with BTIG.
Good morning and congrats on another great quarter.
Thank you.
Thank you, Giuliano.
I guess, jumping back on the BlueMountain topic, are there any opportunities especially with BlueMountain's international exposure to provide more yield oriented investment vehicles to other kind of insurance companies or fixed income investors and leverage the RAP that Assured Guaranty can provide, just thinking about the expansion opportunity because BlueMountain has a fair amount of European exposure already?
Yeah, it's Andrew again. Thanks for the question. We're certainly excited after the first six weeks of starting our integration for the opportunities that we can achieve together through the synergies of the two companies. And certainly one of the areas that we're focused on and have been spending time on is the opportunity to create those kinds of return profiles for international investors and we’re partnering with folks from BlueMountain and from Assured Guaranty's London office to think of a pretty good pipeline of those.
Yeah, thinking of it, one of the things we had to do relative to our international infrastructure business is that market obviously went through tremendous dislocation through the financial crisis and especially related to the behavior of our former competitors over there.
We had to rebuild the investor appetite in the investor marketplace and I actually go out to each of those investors to make sure that they would ultimately start to buy insured paper debt as part of our desire to be a significant player in international infrastructure.
We've been doing a lot of work and the funny thing is now having brought in BlueMountain and Andrew's folks, the amount of contacts [indiscernible] doors that they can open for us to meet with those other investors that we’ve critically wanted to get in front of, now we get to offer them two products as well.
We have always said that we really believe that this is a very synergistic transaction both in the US public finance side and especially in the international infrastructure side and we have just done the most of this last week in London, specifically launching our integration and strategies for what we think is going to be a very bright future for both organizations.
And you mentioned insurance companies, I would mention banks as well. We think there could be a lot of value that we can create together for bank relationships and bank clients across the continent of Europe and in the UK.
That's great. And then going back to a little bit of - the new S&P methodology and the new investment portfolio capital charges. I believe in the past you guys used to get effectively 100% capital charge on BBB’s and also on some private investment vehicles. Can you remind us of roughly of what the BBB capital charges and what private investment vehicles will get in from a capital charge perspective?
Yeah, the BBB capital charges approximately - it is down to only about 6% and private equity capital charges would be about 60%.
Great. Obviously that extends the opportunity pipeline from an investment perspective. Do you know - have you guys made any new comments about the $500 million you plan on investing into BlueMountain funds and the potential timeline of that?
We haven't given you the breakout of that, you can assume that as they've now focused on three core strategies. So we, and as I said, if you look at the historical performance there, obviously, that are significantly better than we are currently getting in the portfolio and now that we're getting more reasonable capital charges relative to [indiscernible] it gives us the ability to put a lot more money to work in what's going to be truly value creation to the insurance operations which create that insurance income which then allows us greater dividend capacity. So it’s going to follow the form of what the asset management strategy currently is deploying.
That's great. I really appreciate it. Thank you very much.
No problem.
Thank you. And the next question, first question comes from Geoffrey Dunn with Dowling & Partners.
Thanks, good morning.
Good morning, Geoff.
Good morning, Geoff.
Rob, can you give me the breakdown of the primary, secondary for public finance both PAR and PVP?
Sure. Primary - PVP primary was $42 million and PAR was $4 billion roughly. Secondary markets, the premium was $4 million and PAR was $194 million.
Okay. And then, how should we think about accretion for next year on BlueMountain. I don't think that we've really talked about any numbers to date. You said it's expected to be accretive. But can you help us frame that up and can you give us some of the balance information as of 930 [ph]
Well, the balance information is the $18 billion of assets under management across multiple strategies. As we look forward to the New Year, we expect because of the wind down of the hedge funds that will take assets out of the portfolio; however, we do have good growth strategies across the other three platforms.
So we think net-net we're going to be up overall in total assets under management. As I said, we're really focusing on management fees. So if you look at the ongoing operations, I think their contribution on a return basis is going to be very, very, very acceptable and we are really at the upper end of what our projected schedule would look at.
However, we have noise in the run-off business and some other areas that we still are addressing. I mean, we closed the transaction October the 1st, obviously, there's a lot of work being done on integration. The integration has a whole lot of technicalities or detailed analysis that have to be performed relative to, as we look at the five common services between the two organizations. We've got to look at what those steps look like, what the ultimate costs are and then obviously a reallocation back.
So all we can really focus on direct expenses at this point in time and the performance of those three strategies being very, very accretive and profitable and we just have to work through the remaining, both rundown of the hedge fund, as well as the integration of the common services to see what the ultimate numbers are going to be. But obviously, we think we're on schedule and we think we're going to achieve the numbers that we thought when we did the original analysis of the potential acquisition.
I think in your supplement last quarter you outlined the range of performance fees on the various funds. How do we think about the overall margin on that?
Well, obviously, if you think in the asset management business in general margins go from say 20% to 40%. Obviously, as we look at really the definition of how do we assess these, what I'll call content services, and what's going to be the right size number to those test [ph], that's going to put us between those ranges.
And remember, Geoff, there'll be - there will be one-time restructuring charges also in 2020 that will offset some of that.
And then you will also have the issue of the amortization and tangible, it's really how you want to look at it at the end of the day, which can give you every number, I think, will give you a pretty good map because we break down the various strategies, the assets under those strategies, the typical fee relationships to those strategies.
So you can get a pretty good idea of where the revenue is and as I said, in terms of direct expenses we're very comfortable. We've got to work through these issues of integration on the common services to see what does the ultimate organization and what it's basically allocation looks like as with the ultimate margin will be.
But obviously the more we improve margins, the more money we make, the more performance we can show to the market because your margin is higher, that means the performance of the company is better, the more assets that's going to attract. So this is all kind of related to obviously building to a really strong conclusion for us.
Okay, thanks.
You're welcome.
Thank you. And as there are no more questions, I would like to return the floor to Robert Tucker for any closing comments.
Thank you, operator. We understand there was a bit of static on the line, and we'll work to quickly get the transcript up. If you do have questions, please feel free to give us a call. Thank you very much for joining us on today's call.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.