Assured Guaranty Ltd. (NYSE:AGO) Q1 2023 Earnings Call Transcript

Assured Guaranty Ltd. (NYSE:AGO) Q1 2023 Earnings Call Transcript May 10, 2023

Operator: Good morning, everyone, and welcome to the Assured Guaranty Ltd. First Quarter 2023 Earnings Conference Call. My name is Bruno, and I’ll be the operator of today. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that 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: Thank you, operator, and thank you all for joining Assured Guaranty for our first quarter 2023 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 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’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.

Dominic Frederico: Thank you, Robert, and welcome to everyone joining today’s call. Assured Guaranty’s new business production was outstanding in the first quarter of 2023. In terms of PVP, it was our most successful first quarter in over a decade. We closed $112 million of PVP in the quarter, up 62% from first quarter of 2022 and double the first quarter average for the previous 10 years. We benefited from the strong start to the year for both Global Structured Finance, which drove its largest amount of first quarter PVP in over a decade; and International Public Finance, the first quarter PVP was the best in five years. Adjusted operating income per share came in at $1.12 for the first quarter. As of March 31, our key non-GAAP valuation measures again reached record levels on a per share basis with adjusted operating shareholders’ equity at $94.58 and adjusted book value of $143.4. Shareholders’ equity per share at quarter end was $88.7 compared to $85.80 for the previous quarter.

Significantly, on April 5, we announced that we reached an agreement with Sound Point Capital Management, which, when implemented will combine the asset management portfolio as of Assured Investment Management and Sound Point to create what we expect to be the CLO’s market’s fifth largest asset manager by AUM. Our first quarter production results showed the strategic execution of our uniquely diversified three-pronged business approach, which includes the U.S. public finance, international infrastructure and global structured finance markets. In the first quarter, the largest contribution to PVP came from Global Structured Finance, which contributed $60 million of PVP, primarily from an insurance securitization and in excess of loss guarantee of a minimum amount of build rent and a diversified portfolio of real estate properties.

We’re also active in whole business securitizations in the subscription finance, which is a promising new market for us. In International Public Finance, we generated $30 million of PVP by guaranteeing several regulated utility transactions as well as a long-term sale and leaseback financing with the Glasgow City Council. Our U.S. public finance business was adversely affected by comparatively low new issuance volume during the first quarter of 2023. Aggregate U.S. municipal market volume was 23% below that of first quarter 2022. However, bond insurance market penetration of 7.7% of par issued remained close to the 8% total for all of 2022 and significantly higher than the 10-year annual average of 6.4%. We continue to lead the U.S. municipal bond insurance market with 60% of insured new issues par sold in the first quarter.

We guaranteed 124 transactions with $3.4 billion of aggregate insured par. We also continue to benefit from institutional investor demand for Assured Guaranty’s insurance on larger transactions. In the first quarter, we insured eight transactions with an insured par of $100 million or more, which totaled approximately $1.6 billion. Among AA credits, defined as those credit S&P and/or Moody’s rate in the AA category on an uninsured basis, Assured Guaranty insured 15 primary market transactions for a total of almost $800 million of insured par during the quarter. We think the fact that investors are willing to accept a lower yield to gain the protection of our guarantee is a testament to the breadth of benefits and our value proposition beyond simply default protection.

Related to asset management and our agreement with Sound Point, we believe the transaction with respect to closing the third quarter will be immediately accretive to earnings per share, return on equity and book value per share. The combination of AssuredIM with Sound Point is subject to certain consents and regulatory approval, and will create an asset management firm that is expected to have approximately $47 billion of total assets under management, with the CLO portion that were ranked fifth in AUM among global CLO managers based on year-end numbers. Under the agreement, we will own 30% of the combined entity at closing. We will contribute to Sound Point on our Assured Investment Management business with certain exceptions, such as Assured Healthcare Partners.

After closing, we will also engage Sound Point as a sole alternative investment manager for AGM and AGC, which are committed to invest over time to total $1 billion to alternative investment strategies managed by Sound Point. That total of $1 billion includes alternative investments and commitments currently being managed by AssuredIM that will be transferred to Sound Point as part of the transaction. At year-end 2022, nearly $400 million of AGM and AGC alternative investments were managed by AssuredIM. To give you a further idea of the scale of this new platform using year-end 2022 amounts, AssuredIM will add approximately $15.2 billion of AUM to Sound Point’s $32 billion, for a total of $47.2 billion. The CLO components of $14.5 billion from AssuredIM and $21.4 billion from Sound Point as of year-end.

This arrangement should further advance our strategic diversification to the asset management business. We have said that we’re looking for alternative, accretive growth strategies to maximize the value to shareholders of our asset management business and to generate a growing earning stream independent of our insurance premiums. We believe our arrangement with Sound Point will accelerate the growth in our earnings from asset management. We intend to jointly create a firm with competitive advantages, including the large-scale essential for leadership in the asset management business, proven success in managing credit focused alternative investment strategies, well-established distribution channels and a stable source of capital for growth opportunities in the asset management business.

Our desire to enter into this transaction with Sound Point was based on our confidence in Sound Point’s proven ability to raise LP funds and to produce attractive alternative investment returns. We believe the addition of AssuredIM’s AUM and AGM and AGC’s capital commitments can further strengthen Sound Point and enhance the combined entity’s profitability as well as its ability to increase the investment returns of our insurance subsidiaries. This would further support their capacity to upstream dividends to the holding company and, ultimately, to shareholders. Turning to Puerto Rico, our last remaining unsettled defaulted Puerto Rico exposure is the Electric Power Authority, PREPA. The PROMESA court has again directed the parties to engage in good faith mediation in an effort to reach an agreement before the confirmation hearing scheduled for late July.

We remain committed to negotiate a fair and reasonable settlement with PREPA. But if necessary, we’ll protect and enforce our rights as bondholders through litigation and the federal three plan (ph) confirmation process. Looking forward, I’m optimistic about our prospects for the year and beyond, with our international infrastructure and structured finance businesses have good pipelines of opportunities and the U.S. public finance business should continue to benefit from the more steady transaction flow that is typical in that market. Inflation and the last year of [indiscernible] Fed action continued to have a significant impact on the municipal bond market. Compared with last year’s first quarter when the AAA 30-year Municipal Benchmark Index averaged 2%, the average for this year’s first quarter was 3.4%.

Additionally, credit spreads, which can be equally, if not more important to our business, widened significantly during 2022 and remained steady during the first quarter. We believe these factors should be positive for our business going forward. Market volatility, economic and geopolitical uncertainty and recession fears tend to be conducive to greater investor demand for our product. Importantly, for over 35 years, our business model has proven its resiliency in unpredictable and stressful economic times, while protecting our company’s financial strength and shareholder value while we still got our policyholders and save money for issuers. I believe there is a good chance, the market is entering the kind of sustained interest rate and credit spread conditions that I’ve often said would allow for significant growth in our financial guarantee business.

Conditions that would likely give us more opportunities to add value as well as increased pricing flexibility. Our insured portfolio and financial condition are as strong as or stronger than ever, and we expect our new asset management approach to be highly beneficial. I will now turn the call over to Rob.

Robert Bailenson: Thank you, Dominic, and good morning to everyone on the call. I am pleased to report first quarter 2023 adjusted operating income of $68 million or $1.12 per share. This compares to adjusted operating income of $90 million or $1.34 per share in the first quarter of last year, which included a $63 million net benefit associated with the Puerto Rico settlements that occurred last March. Largest component of adjusted operating income was the Insurance segment, which contributed $117 million of adjusted operating income in the first quarter of 2023 compared with $133 million in the same period of last year. Excluding the benefit for Puerto Rico settlements from last year’s results, Insurance segment adjusted operating income increased due to higher net asset values for alternative investments, higher investment income and the release of a litigation accrual.

Investment results from both the fixed maturity and the alternative investment portfolios performed very well in the first quarter of 2023, with total income from investments of $110 million compared with $58 million in the first quarter of last year. The available-for-sale portfolio generated net investment income of $82 million in the first quarter of 2023, up from $63 million in the first quarter of 2022. Higher income from floating rate assets as well as higher interest rates and average balances in the short-term portfolio were the primary drivers of the increase. Equity and earnings from alternative investments, predominantly generated by the AssuredIM CLO and Healthcare funds was a gain of $30 million in the first quarter of 2023 compared with a net loss of $1 million in the first quarter of last year.

Annualized returns for the AssuredIM funds were 10.7%, which is in line with our long-term expectation for these investments. With respect to premiums and losses, the variance in both line items is primarily — was primarily driven by the impact of the Puerto Rico settlements in March of last year, which resulted in net earned premium accelerations of $104 million and loss expense of $29 million. Net earned premiums and credit derivative revenues were $84 million in the first quarter of 2023, compared with $219 million in the first quarter of last year. Excluding the first quarter 2020 effects of the Puerto Rico settlements, scheduled net earned premiums and credit derivative revenues were relatively consistent quarter-over-quarter as new businesses kept pace with the scheduled amortization and refundings in the insured portfolio.

Deferred premium revenue remained steady at approximately $3.7 billion, where it has been for the past year. Non-Puerto Rico accelerations were $4 million in the first quarter of 2023 compared with $26 million in the first quarter of last year, as refunding activity has slowed down in recent years. Loss expense in the first quarter of 2023 was $9 million and economic development was $11 million. The primary driver of both measures was the change in risk free rates used to discount losses. With respect to operating expenses, the first quarter of 2023 ran higher than our normal run rate due in part to severance and legal expenses related to the Sound Point transaction and an additional U.K. value-added tax, which together totaled approximately $15 million.

These unusual items affected each of the segments in the corporate division and were the primary driver of the increase in Corporate division adjusted operating loss from $33 million to $44 million. Turning to the Asset Management segment. We are committed to the Sound Point transaction, which we expect to close in the third quarter of this year. As a result, we have designated transferring AssuredIM business as well as the remaining Healthcare business as held for sale on our balance sheet and we have stopped amortizing the related intangibles. From a reporting perspective, the transformation of our Asset Management business from a wholly-owned business to a minority stake in a larger Sound Point combined entity continues to give Assured Guaranty ongoing earnings based on asset management fees, and increases our ability to expand into alternative investments while simplifying our reporting structure and financial statements.

Upon closing, we expect that we will deconsolidate most, if not all, of the CLOs and AssuredIM funds. The result will be more straightforward, one-line investment in Sound Point and in each of the funds using the equity method of accounting. As Dominic mentioned, we’ve agreed after closing to invest $1 billion in Sound Point managed alternative investments, subject to regulatory approval. This commitment includes almost $400 million of existing investments and commitments in AssuredIM CLO and asset-based funds that will transfer to Sound Point. Adding inception-to-date distributed gains, our current authorization for alternative investments through our investment subsidiary, AGAS is $853 million and is available for investment in both Sound Point investment vehicles and the Assured Healthcare Partners strategy.

As we continue to shift more of the investment portfolio to alternative investments, net investment income from fixed maturity securities may decline. However, over the long term, we expect returns on the alternative investment portfolio of over 10%, which exceeds the projected returns on the fixed maturity portfolio. In addition to meeting two of our key objectives in Asset Management and alternative investments with the Sound Point transaction, we continue to focus on our other long-term strategic initiatives to grow the company and enhance shareholder value. In the Insurance segment, strong production in the international public finance and structured finance markets provide diversified sources of new business and are accretive to key book value metrics.

On the loss mitigation front, we continue to strategically divest the remaining recovery bonds and contingent value instruments that we received last year as part of the resolution of the majority of our Puerto Rico insured exposures in order to maximize our economic benefit. We also continue to work towards resolution of our PREPA and short exposure. As of May 5, we have sold approximately 91% of the recovery bonds in the investment portfolio, 35% of the contingent value instruments. Based on fair value, we have approximately $81 million in recovery bonds and $324 million in contingent value instruments remaining in our investment portfolio. In terms of holding company liquidity, we currently have cash and investments of approximately $165 million, of which $48 million resides in AGL.

These funds are available for debt service and corporate operating expenses or for use in the pursuit of our strategic initiatives, including potentially refinancing or redeeming debt and repurchasing shares to manage our capital. As we said in our last call — our last call last quarter, we currently have $201 million of remaining authorization and expect to resume share repurchases in the second half of the year. However, even without share repurchases, in the first quarter of 2023, operating shareholders’ equity and adjusted book value per share reached new records of over $94 million and $143 million, respectively, due to positive adjusted operating income and strong new business production results for the quarter, demonstrating the value of all our initiatives.

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

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Thomas McJoynt from KBW. Thomas, your line is now open. Please go ahead.

Operator: Our next question comes from Giuliano Bologna from Compass Point. Giuliano, Your line is open. Please go ahead.

Operator: Our next question comes from Jordan from Philadelphia Financial. Jordan, your line is now open. Please go ahead.

Operator: Our next question comes from Brian Meredith from UBS. Brian, your line is now open. Please go ahead.

Operator: We currently have no further questions. So I would like to hand the call over back to Robert Tucker. Please go ahead. .

Robert Tucker: 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: Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines. Thank you.