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Edited Transcript of AGO earnings conference call or presentation 23-Feb-18 1:00pm GMT

Q4 2017 Assured Guaranty Ltd Earnings Call

Hamilton Feb 24, 2018 (Thomson StreetEvents) -- Edited Transcript of Assured Guaranty Ltd earnings conference call or presentation Friday, February 23, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dominic John Frederico

Assured Guaranty Ltd. - Deputy Chairman, President & CEO

* Robert Adam Bailenson

Assured Guaranty Ltd. - CFO & CAO

* Robert S. Tucker

Assured Guaranty Ltd. - Senior MD, IR & Corporate Communications

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Conference Call Participants

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* Bose Thomas George

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* David Michael Einhorn

Greenlight Capital Re, Ltd. - Chairman of the Board

* Geoffrey Murray Dunn

Dowling & Partners Securities, LLC - Partner

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Assured Guaranty Ltd. 2017 Fourth Quarter and Year-end Earnings Conference Call. (Operator Instructions) And please note that today's event is being recorded.

I would now like to turn the conference over to Robert Tucker, Senior Managing Director, Investor Relations and Corporate Communications. Please go ahead.

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Robert S. Tucker, Assured Guaranty Ltd. - Senior MD, IR & Corporate Communications [2]

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Thank you, operator, and thank you all for joining Assured Guaranty for our 2017 fourth quarter and year-end 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 the 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 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 Ltd.; and Rob Bailenson, our Chief Financial Officer. After their remarks, we'll open the call to your questions. (Operator Instructions)

I will now turn the call over to Dominic.

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [3]

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Thank you, Robert, and welcome to everyone joining today's call. In 2017, Assured Guaranty demonstrated once again that our long-term vision, well-conceived strategy and skilled execution can create impressive growth in the value of our company. We earned $661 million in non-GAAP operating income, increased our non-GAAP adjusted book value to $9 billion for the first time, further advanced our financial strength and broadened the scope of the company, all while paying substantial claims to protect insured bondholders.

Our 2017 accomplishments include our greatest annual dollar increase in non-GAAP adjusted book value per share, which ended the year at a record $77.74, up 17% from a year earlier. A record year-end non-GAAP operating shareholders' equity per share of $56.20, 13% higher than a year earlier; the return to shareholders of $571 million of excess capital through $70 million in dividends and repurchases of 12.7 million common shares; a 35% annual growth in the present value of new business production, or PVP, which reached $289 million, the highest annual amount since 2010; a widening of our leadership in the U.S. municipal bond insurance market, guaranteeing more than 58% of insured par sold; the completion of our acquisition of the European arm of MBIA Insurance Corporation, which generated $57 million of after-tax gain and increased non-GAAP adjusted book value by $322 million at the acquisition date. Our first direct investment in an asset management firm as part of our strategy to identify alternative investments that complement our existing financial guaranty business, provide accretive returns and complement our core strengths. And the continued success and loss mitigation efforts, one of our key strategies, including a major RMBS settlement in the fourth quarter for a pretax gain of $105 million.

In new business production, we saw significant contributions from all 3 of our financial guarantee markets: U.S. public finance, international infrastructure finance and U.S. and international structured finance. And we increased overall PVP for the fourth consecutive year. We accomplished this in a year of continued low interest rates, exceptionally tight credit spreads and disturbing headlines about the plight of the Puerto Rican people and the illegal behavior of the Puerto Rico government and Oversight Board.

In the primary municipal bond market, we continue to lead the industry in both -- in terms of both par and the number of transactions insured. Issuers continue to increase their use of our insurance on larger deals, attaching AGM insurance to 23 new issues with $100 million or more of AGM insured par.

We also led the industry in a number of smaller transactions, with AGM and MAC guaranteeing almost 400 bank-qualified issues.

Importantly, for the second consecutive year, PVP generated in the secondary market was in the vicinity of 30% of total U.S. public finance PVP. In 2017, we insured approximately $1.7 billion of secondary market par. When we count all of our 2017 U.S. public finance business, including transactions in both the primary and secondary markets, Assured Guaranty generated U.S. public finance PVP of $196 million, a year-over-year increase of 22%.

On the international side, Assured Guaranty's performance is even more noteworthy during 2017. International infrastructure transactions generated $66 million of PVP, $14 million more than in the previous 2 years combined. The transactions we closed show we've returned to being an important player in international infrastructure capital markets, particularly in the United Kingdom. We closed 3 transactions in the U.K. student housing center, where we see ongoing opportunities, and insured a GBP 261 million refinancing for St. James's Hospital in Leeds, one of the largest teaching hospitals in Europe. We also issued a long-term financial guaranty that improves the debt service liquidity for bonds issued to refinance Eurotunnel, introducing to Europe an application of our guaranty that has the potential to enhance long-term debt service liquidity for many other issuers.

It is also interesting to note that in 2017, we insured 2 transactions located outside of the U.K., which further reflects the recognition, value and acceptance of our guaranty in the European market. Because international infrastructure transactions often take a long time to complete, transaction flows tend to be less regular and the timing of closings is not easy to predict. It is, therefore, encouraging that we've generated PVP in the international market for 9 consecutive quarters. While we're still likely to see some volatility in international production, it is clear we have the value proposition and acceptance to succeed in this market.

In January 2017, we expanded our international presence by completing our acquisition of MBIA's European operating subsidiary, which we renamed Assured Guaranty (London). The acquisition added approximately $12 billion of primarily European infrastructure and utility transactions to our insured portfolio. In time, we believe we can ultimately simplify our international corporate structure and enhance our market visibility by consolidating all of our European insurance subsidiaries under the brand name of AGM's U.K. subsidiary, Assured Guaranty Europe.

Our structured finance business was also productive in 2017, generating $27 million of PVP in a variety of market sectors. It is important to note that this figure excludes a significant amount of PVP that was generated from a municipal structured transaction that was executed by the structured finance group but accounted for as of U.S. public finance sector. The aviation sector was also a focus where we executed a number of residual value transactions on aviation equipment, and we are -- we also focused on the capital management solutions for various institutions such as life insurance reserve financing and risk transfers for regulatory compliance.

Additionally, we wrote secondary market policies on some asset securitizations to demonstrate the value of our guarantees in the asset-backed market, where we do see additional opportunities in consumer loan, auto loan and hold business securitizations. This secondary market program has stimulated interest in our guarantees in the primary asset-backed market.

During the year, S&P Global ratings conducted its comprehensive annual review of Assured Guaranty and reaffirmed once again AA stable financial strength rating it assigns to our principal operating subsidiaries. Separately, Kroll Bond Rating Agency reaffirmed its AA+ stable rating for MAC, its AA stable ratings for AGC. And in January 2018, its AA+ stable rating for AGM. As for Moody's, we have long disputed their subjective methodology and their disregard for the quantifiable improvement in our financial strength. Given AGC's AA stable ratings from both S&P and Kroll Bond Rating Agency, we no longer consider a Moody's rating essential for AGC and ask Moody's to withdraw its AGC rating.

Our continued financial strength results from our fundamental credit discipline combined with continued execution of alternative strategies. Over the 10 years, from 2008 to 2017, we have maintained our total claims-paying resources at approximately $12 billion, which is a remarkable achievement considering that during that period, we paid out more than $7.1 billion, comprising $4.4 billion in net claim payments to keep insurers -- insured investors whole over $535 million in dividends to shareholders and $2.2 billion to repurchase 42% of the common shares outstanding at the beginning of our repurchase program in 2013.

Acquisition of legacy bond insurers or assuming their insured portfolios to reinsurance results in large and immediate increases to the size of our insured portfolio, which is equivalent to writing new policies in the same par amount. Such acquisitions add to the reserve of unearned premiums that set a predictable floor for each quarter's revenues. Just this month, we announced that we would reinsure substantially all of Syncora Inc.'s insured portfolio and commute a significant portion of the exposure we had previously ceded to Syncora. This transaction is expected to close by the end of the second quarter.

Our alternative investments group is also a test with identifying and investing in other types of businesses where there's synergy with our core competencies, a risk profile in line with ours and high potential for attractive returns. One source of these opportunities is the asset management field. And during 2017, we purchased a limited partnership in a fund that invests in the equity of private equity managers.

We also purchased a minority interest in investment advisory, Wasmer, Schroeder & Company, a highly regarded independent investment advisory firm that is a great strategic fit. Assured Guaranty and Wasmer, Schroeder have complementary strengths in municipal credit analysis, and both have extensive relationships in the public finance market. We expect to support the continued growth of Wasmer, Schroeder, as it seeks acquisitions of other fixed income asset management firms.

Our pursuit of acquisitions and alternative investments is one way we reduce our excess capital, as our insured portfolio amortizes and our leverage ratios decline. We saw the ratio of our statutory net par outstanding to total claims-paying resources declined to 20 to 1 at year-end 2017 from 2 -- 22 to 1 at the beginning of the year. We are also committed to a capital management program focused on increasing shareholder value. In 2017, we met our stated goal of repurchasing $500 million of shares annually to increase our value per share.

To continue our capital management program, we need to upstream sufficient capital from our operating subsidiaries to our publicly traded holding company, while keeping a watchful eye on the appropriate capitalization for each of our insurance companies and also in hearings on the dividend limitations set by the regulators.

In September, we rebalanced assets of our U.S. subsidiaries through MAC's repurchase of $250 million of its own shares from its immediate holding company, which is jointly owned by AGM and AGC. The cash from the repurchase was distributed to AGM and AGC in proportion to their ownership, providing those companies with additional liquidity for upstreaming dividends or redeeming stock.

Then in the fourth quarter of 2017, we obtained permission from the Maryland Insurance Administration and the New York Department of Financial Services to redeem $200 million of AGC stock and $101 million of AGM stock, respectively. These purchases provide funds to the parent company that may ultimately be used for share repurchases or alternative investments.

Another key strategy is loss mitigation. We've been very successful over the years in obtaining recoveries for breaches for rep and warranties in RMBS transactions. And with the significant settlement, we concluded in the fourth quarter, concerns about our exposures in that sector are substantially behind us.

On the public finance side, we are focused on helping Puerto Rico set itself on a path to economic recovery and the future access to the capital markets. After Hurricane Maria, we voluntary withdrew without prejudice an adversary complaint we had filed to challenge legality at the original Puerto Rico fiscal plan that the Oversight Board had certified. The plan violated numerous provisions of PROMESA and the law and constitutions of both Puerto Rico and the United States. We withdrew the complaint to remove a distraction from the recovery efforts and because it was clear that the previous certified plan would have to be revised. In a common sense world, which is clearly absent in Puerto Rico, the need to revise the plan should have facilitated new collaboration between the federal oversight board, the Commonwealth and its creditors. Instead, the revised plan the government submitted not only squandering the opportunity to correct the flow of the original plan, it actually exacerbated them. After the board demanded further revisions, there is now a revised, revised plan that still offers neither a path to economic revitalization and restoration of capital market access, nor credible basis for debt restructuring. We joined other creditors in a February 14 public letter to the Oversight Board that outlined the current proposal's many deficiencies. I will mention a few today.

The plan contradicts itself by assuming a massive outward migration and a 20% decline in population without substantial support and/or any government plans or strategy to stem this decline. It also makes contradictory projections about increases to health care costs and government expenses despite this projected falling population. It also fails to distinguish between essential and nonessential expenditures and contains no detailed program for a meaningful reduction in government spending. Incredibly, the plan does allocate hundreds of millions of dollars for litigation expense and outsized adviser fees while providing no debt service, reflecting the government's determination to litigate rather than involve creditors and other stakeholders in developing a comprehensive consensual solution. Certifying such a plan is a disservice to the citizens of Puerto Rico, who will bear the cost of this litigation and lack of market access for years to come.

Additionally, no plan should be certified until all stakeholders know the government's true financial position. Puerto Rico must provide transparent disclosure of its audited 2015 and 2016 financial statements, the data underlying the government's assumptions and timely and up-to-date information about all financial accounts available to the government. 4.5 months after Hurricane Maria, we still do not have reliable estimates of the cost of restoring normalcy to the island, and the full amount of relief aid that will be available from the federal government is much less the long-term economic impact of the disaster. All stakeholders should be focused cooperatively on the immediate recovery needs of Puerto Rico. A first step would be for the Oversight Board and the creditors of Puerto Rico Electric Power Authority to agree on a well-qualified, experienced receiver the court could approve to steer PREPA through its current emergency and away from the corruption, political meddling and general mismanagement that has led to such scandals as the infamous Whitefish contract, the discovery of a warehouse full of restoration materials and alleged bribes solicited by restoration workers.

Talks of privatizing PREPA, without involving its creditors, is a nonstarter and will only cause further disruption to the reconstruction of PREPA and delay any real improvement in operation due to litigation that will result from ignoring creditors' legal rights. If the Commonwealth and Oversight Board continue to ignore legal and constitutional rights of creditors and resist working constructively towards a consensual restructuring, costly litigation will continue for the foreseeable future. We expect that creditors will ultimately prevail in these avoidable court room disputes for a number of reasons. One of which is that the Puerto Rico Constitution is crystal clear that GO bonds get paid first and that claw backs can only be used to pay debt service on Commonwealth debt. And PROMESA requires that physical plans must respect constitutional priorities and contractual liens. But if the (inaudible) attempts to retroactively treat creditors unfairly, the news will reverberate across the United States, undermining municipal bond investors' confidence in the terms of their contracts and then politicians' willingness to abide by the commitments they make or inherit. Advocates of repudiating the debt are either oblivious, ill-informed or vastly underestimate the far-reaching implications of actually doing so. Such blatant disregard for the rule of law would make it more expensive for municipalities throughout the United States to fund essential services and infrastructure. This also applies to revenue bonds like those of the highway and transportation authority. The Title III court has turned a blind eye to the legislative history and the context and purpose of special revenue provisions by failing to order the transportation agency to turn over revenues for debt service while the Title III case is pending. If this ruling is allowed to stand, it will call in the question an important investor protection that is fundamental to the revenue bond market. We will be appealing that ruling.

The developments in Puerto Rico have demonstrated the value of our guaranty for both default protection and the support of insured bonds and market value. As we continue to defend our rights and convey our message unequivocally to all parties involved in the Puerto Rico negotiations, we know we have the capital and liquidity to continue the effort as long as necessary.

We also have the confidence in knowing that our financial strength will continue to protect holders of Assured Guaranty insured bonds. While Puerto Rico seeks to avoid paying its debt, other United States territories and municipalities have taken a different approach.

For example, both Guam and the Virgin Islands have said they intend to fully repay their debt obligations and respect the rights of creditors and the rule of law. They serve as a current example of the prudent way municipality or territory can deal with adversity while understanding the importance of maintaining access to the capital markets in order to support their recovery as well as their future growth and sustainability.

As we have seen with past municipal bankruptcies, working closely with creditors and tapping their expertise to help navigate complicated debt restructuring is the optimal path to emerging out of bankruptcy proceedings.

Looking toward the year ahead, we remain focused on our central objective to build long-term value for our policyholders and shareholders. Indications are that the Federal Reserve rate setting committee will continue to raise short-term rates gradually, notwithstanding recent stock market volatility. They should eventually push up long-term rates, which has historically led to wider credit spreads and greater demand for bond insurance. This may take time, however, to really experience the benefit of increased demand for insurance.

Additionally, the new tax regime is likely to have mixed effects on the municipal bond market, potentially including reduced new issue volume and higher yields because the reduced demand from institutional investors now enjoying lower tax rates. Rob will speak in a moment about the more direct effects of tax reform on Assured Guaranty.

A potential wild card is what effect, if any, proposed federal infrastructure legislation may have on the U.S. public finance business. While we must be prepared for a potential decline in total U.S. public finance issuance in 2018, we believe the market is increasingly recognizing the value of our product. We have the additional advantage of a diversified strategy that includes international infrastructure finance and structured finance. In both of these markets, we are seeing growing recognition of our value proposition along with regulatory incentives to use our products to manage capital more efficiently. Additionally, our internal -- our alternative investment strategy provides a separate avenue towards growth and positive results, and our capital management program will continue to benefit shareholders.

Our business model has proven to be successful for more than 3 decades. As we build on that success, we continually evaluate the environment and pursue new opportunities to put capital to work effectively. Assured Guaranty is in a very strong financial position, and we have the strategy and resources for continued success in protecting policyholders and creating value for shareholders.

I will now turn the call over to Rob.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [4]

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Thanks, Dominic, and good morning to everyone on the call. As Dominic mentioned, 2017 was another successful year where the execution of our strategic initiatives contributed to our key financial metrics, which I will highlight in a minute. But first, I'd like to comment on the impact to Assured Guaranty related to tax reform that was enacted in December.

We believe that tax reform will be a net positive going forward, as we expect non-GAAP operating income effective tax rate to decrease to approximately 14% to 16%, though the rate will vary as it has in the past due to the portion of income in different tax jurisdictions in any given period.

From an adjusted book value perspective, the decrease in corporate tax rates from 35% to 21% was a benefit of approximately $239 million or $2.06 per share because ABV includes unearned premium reserve that is now reflected at a lower tax rate.

The immediate impact to non-GAAP operating income was an estimated charge of $35 million in the fourth quarter of 2017 comprised of a $24 million charge due to the deemed repatriation of undistributed bond earnings of our U.K. subsidiaries and an $11 million write-down of deferred tax assets attributable to the reduction of corporate tax rates.

Please note, this differs from the GAAP charge of $61 million because it adjusts for the portion of deferred tax asset and liability write-down that are related to non-GAAP adjustments such as mark-to-market adjustments on CDS.

Operating income, including this tax reform charge, was $91 million in the fourth quarter of 2017 compared with $139 million for the fourth quarter of 2016. The fourth quarter of 2017 included lower net earned premiums, offset in part, by a benefit on an R&W settlement associated with a transaction that was part of the CIFG acquisition.

Economic loss development during the fourth quarter of 2017 was a loss of $15 million, primarily related to Puerto Rico exposures that reflect the revised fiscal plan, which inappropriately reduced the amount of debt service available to pay creditors. The increase was partially offset by a $111 million benefit in the U.S. RMBS attributable mainly to an R&W settlement. The change in risk-free rates used to discount losses resulted in a benefit of $3 million.

Net earned premiums and credit derivative revenues were $185 million in the fourth quarter of 2017 compared with $261 million in the fourth quarter of 2016. The decrease was due primarily to lower refundings and terminations, which were $82 million in the fourth quarter of 2017 compared with $137 million in the fourth quarter of 2016. It should be noted that the tax reform act also includes provisions that repealed the tax treatment of advanced refunding bonds, which may result in a lower volume of municipal obligation refundings in the future.

Turning to the full year. Operating income was $661 million and reflects the impact of other strategic initiatives undertaken in 2017, including the commutation of reinsurance relating to 3 previously ceded portfolios, resulting in the reassumption of $5.1 billion of par and $82 million of unearned premium reserve generating a pretax commutation gain of $328 million or $213 million after tax. And the completion of the MBIA UK acquisition, which not only increased our UPR but also resulted in an after-tax gain of $57 million and an increase in adjusted book value of $332 million.

Throughout 2017, we significantly increased Puerto Rico REIT losses as new developments emerged, which was the primary driver of the $313 million economic loss development for the year. This was net of benefits from our loss mitigation strategies.

In terms of capital management activities, in 2017, the New York and Maryland regulators approved a total of $301 million in the AGC and AGM share repurchases. In 2017, AGM transferred $101 million; and in 2018, AGC transferred $200 million to their respective U.S. parent holding companies in exchange for the shares held by the parent. This is the funding mechanism principally used to achieve our share repurchase objectives, and it is what we had previously referred to as a special dividend.

As a result, as of January 31, 2018, we had cash and investments available for liquidity needs, capital management activities and other strategic opportunities of $11 million at the Bermuda holding company and $505 million at the U.S. holding companies.

During the fourth quarter of 2017, we repurchased 1.9 million shares for $70 million, bringing full year 2017 repurchases to 12.7 million shares or $501 million at an average price of $39.57 per share. Since 2013 and through today, we have repurchased approximately 43% of the total shares that were outstanding at the start of our share repurchase initiative. The cumulative impact of the repurchases from 2013 to the end of 2017 was a contribution of approximately $11.80 per share to operating shareholders' equity and over $20 to adjusted book value per share.

Further commitment to our shareholders is reflected in the increase in our dividends to common shareholders. Our current dividend announcements of $0.16 per share represents a 23% increase over 2016 dividends. The company's successful execution of its diversified strategy has led to new records for non-GAAP operating shareholders' equity per share and non-GAAP adjusted book value per share of $56.20 and $77.74, respectively, and leaves us in great position to pursue continued repurchases, alternative investments and/or acquisitions.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today will be Bose George with KBW.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [2]

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Actually, the first question is just on the capital return. On the last call, you guys noted, I think, about $500 million expectation for 2018. With the redemptions here from AGM and AGC, you already have the special, so you're already kind of positioned for that. So just in terms of going forward, will the next special dividend request be for 2019? And then in terms of the pace of the buybacks, is it going to continue to be spread out over the year? Or could you do something accelerated over here?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [3]

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Well, as we've said, the $500 million is an annual target, not necessarily going to be achieved in every 12 calendar months but over the flow of the period. That's what we hope to achieve. Number two, we always need the help of a special dividend request at some time in the year because the operating dividend capacity of the subsidiaries will not be enough to reach that total. So each year and typically towards the end of the year, we put the request and towards the middle end, and they get approval at the end. And as I said before, we wanted to be kind of automatic with the regulators, so that it's an amount that we're very comfortable as they look at the financial strength of the organization. However, we have other cash needs as well at the parent company, and we still continue to evaluate our alternative strategy program in terms of making other investments that will provide growth and accretive returns to the organization. So we have a goal. We have a methodology to achieve that goal, and we'll continue to execute our strategies across all the various disciplines that we evaluate as we look to put the money to work.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [4]

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Okay, great. And then actually, switching over to Syncora transaction. Can you give us some indication of the potential accretion from that?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [5]

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Well, the portfolio of risk that we were able to re-underwrite and assessed only the risk that met our underwriting standards at a pricing value that is above current market availability. This will be a different effective transaction than other transactions we have done in that you'll earn the benefit, the accretion over time. And therefore, in any given period, it's just as matter -- who we wrote new business at a better premium rate relative to the current rate. So it more comes in as a higher ROE per deal as it is opposed to specific accretion for a value of the transaction because the nature of the earning and the timing.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [6]

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I mean, it's going to be accretive to all of our measures. It depends when it closes as well. But on an annual basis, we think it'll increase earned premium to the extent of some -- between $25 million and $30 million because we're writing about $360 million of premium. So we -- it depends on when it closes, but I would use in the first year or full year would be about $25 million to $30 million of earned premium.

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Bose Thomas George, Keefe, Bruyette, & Woods, Inc., Research Division - MD [7]

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Okay, great. And then actually just one more on the higher rate environment, can you sort of quantify the potential benefit to the investment portfolio from higher rates here?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [8]

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Well, remember, we talked about -- I guess it goes back to late third quarter of '16, where we see the run-up in rates and also the Trump effect last year in the election, where we saw an immediate increased spike in demand. We always felt that a 50% rate improvement probably improves production opportunity by a percentage equal to that. But as you go up the scale, the relationship between increased opportunity against rate increases becomes geometric, not linear. So it's really hard to predict. And of course, with the tax reform potentially having other impacts on issuance, et cetera, and maybe demand for municipal bonds, it's going to be hard to determine the exact value. All we can say is, in the long run, increased interest rates benefit our company, benefits our insured portfolio, benefits our investment portfolio and benefits the demand for the product.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [9]

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And we also do see -- I mean to your question on investment portfolio, we see the increase in rates as a benefit. And also, our duration, our portfolio is anywhere between 5 to 6 years. In addition to which with tax reform, there is an advantage to actually shifting some taxable munis, which could also increase our investment portfolio and our total return in the investment portfolio.

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Operator [10]

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And our next question will be Michael Temple, a private investor.

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Unidentified Participant, [11]

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A series of quick questions, but I hope you can bear with me. Regarding the categorization of the Syncora transaction, when I take that face amount, which I guess, was approximately $14 billion of insured, and if I simply give you credit for duplicating your 2017 production of roughly $18 billion, again, giving you no growth for 2018, and measure that against your anticipated runoff of existing insured, I actually come up with a number for 2018, which for perhaps the first time since 2009, your book will not amortize, it will actually show a modest uptick. Am I doing that calculation correctly, if we assume that you do $18 billion in production this year equal to what 2017 was?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [12]

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Yes, you are correct. And if you remember, in previous calls, we'd always refer to when we would hope to see the balance in the portfolio amortization, and we expected it around 2020. However, transactions like this as well as the recapture of reinsurance last year begins to build back the portfolio in addition towards normal production efforts in terms of the new business market, new issue the market provides. So we've looked at the issue. We've tried to calculate our own balance to see when do we start building back the unearned premium reserve, realizing that these transactions could have a significant impact on when that balance occurs. So hopefully, we're getting ahead of that balance period, which is a positive thing, start building up the earning story of the company.

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Unidentified Participant, [13]

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And a follow-up to that. So if we exclude the one-time nature of the Syncora transaction, and again just look at the $18 billion in face from last year, do you believe -- I mean, I know you're loathe to give precise guidance, but do you believe with the trend in interest rates and perhaps more importantly, going by the wayside of National now that they are no longer writing new business, the combination of higher anticipated rates and the fact that your market share might move markedly higher from the current 58%? Should we be optimistic that we will see that $18 billion figure from last year improved upon going forward?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [14]

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Well, we always try to incentivize our production people to achieve greater results year after year. Obviously, that's how we build a budget. That's how we build incentive opportunities in terms of compensation or performance base. So obviously, we expect the continued growth. And as I said, most of the work we've done over the past few years was rebuilding the reputation of the financial guaranty and especially in the international markets. And to your point, we believe the international markets probably represents a stronger growth opportunity at this point in time than domestic. And the other reason for that is there is this wildcard out there called both the tax reform and the infrastructure bill, whatever that looks like when it gets passed. So those 2 things really will have an impact on demand. Kind of hard to determine exactly in which direction, as we said, with the lower rates, the need to buy municipal bonds because less. However, on the individual side and the retail side, it becomes more because obviously the top rate didn't change much in a lot of individual exemptions or deductions we're done away with. So it's hard at this point in time to make that call. Obviously, we expect to continue to build the infrastructure or the platform that we operate under or optimistic about our chances in all marketplaces because of our diversified strategy. We see positive trends in both interest rates and the acceptance of the products. So long answer to a short question, we expect our volumes to hopefully increase. But once again, there's enough factors out there that's going to still allow this to be a developing story, as we see how certain things take hold through 2018. And of course, we'll just look for other acquisition opportunities that will further benefit the portfolio to the extent that they become available.

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Unidentified Participant, [15]

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Okay. A couple of just quick ones. As you talk about your overseas growth, are there opportunities for your services in the Far East where, again, we famously keep hearing about the China One Belt One Road? I know that's more of a governmental initiatives from them. But are there opportunities for you in the Far East? Or is that longer term something that we could look to? Or is it principally U.K. and Europe that you see your services being utilized?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [16]

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A couple of things. So there's -- obviously, we always look to benefit our franchise, make what I'll call complementary and strategic either acquisitions or investments that basically benefit both the entity that we're looking at as part of the diversified strategy as well as our core financial guaranty business. So that's as best as I can tell you without telling you more than I can tell you. Number two, if you noticed, we've been dominant in the U.K. as our international platform. We've had operations before in other locations and just into the long-term commitment demand or the necessary market specifics to really foster our type of product. [We really not] show you for the sake of argument, but they really didn't have any long-term financing obligations. Everything was financed on a short-term basis. However, we do see changes in that market. As I said in my commentary, for the first time in my memory, we've done risks that are outside citing U.K. risks in this current year. We anticipate further increasing those operations or opportunities as well as these strategic acquisitions or things that we're considering should also further our international platform. So our object is to make sure we continue to support financial guaranty, provide attractive investments that not only provide us growth and opportunity to expand our platform but also ties along with the Assured Guaranty financial guaranty product as another way to access new markets. Obviously, any environment we look at must have rule of law. We believe that the United States will continue to have rule of law, which is going to be critical in the Puerto Rico environment, and that's another part of how we have to look at expansion overseas. So yes, we look at international. It's a great platform, great opportunity. We are expanding out of the U.K. We have plans for further international growth tied to some other things that we're working on today. And obviously, that's in the hope of driving that franchise because of its value to us and the fact that in the financial guaranty space, we have no competitors in that marketplace.

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Unidentified Participant, [17]

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And then final question regarding Puerto Rico. Clearly, you and other creditors had to be heartened by Judge Swain's recent actions on the PREPA loan that Puerto Rico was seeking. I'm just curious if we should read into that, that you expect further observation of the rule of law from this judge in other matters that come before her? And any hint or detection that the Puerto Rican government has perhaps begun to realize that the scorched-earth tactics they've been taking are not being met with favor by this Court?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [18]

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Okay. I got to be really careful here because you're getting me into a topic that's where I like to. Anyway, so I'm not heartened by anything Judge Swain does, so let me very clear. They do not need the loan in PREPA. All they had to do was collect their utility bills from principally municipal authorities to which the government has the ability and especially with the aid money coming in to support those authorities in paying their electric bills. If you paid your electric bill, there is no need for cash from PREPA. Therefore, the loan is just another way of trying to prime creditors in which I do not accept, and we will litigate that issue specifically. This judge needs to understand that she's in a position to reestablish rule of law, which is critical to the entire behavior of our financial markets. Just imagine, at all of our businesses, if somehow retroactively all contracts or rights can be taken away from you, that chaos that would ensue in the financial market in the United States, and that's the exact path this judge is going down. So this is going to be a fight in court. We're going to appeal every decision and everything that the government puts in front of us. We believe relief will come when we get the first appeal heard, especially say on the transportation revenue. And hopefully, that happens in a very reasonable period of time. And when that first reversal comes back, then I think you'll see changes in behavior and a real commitment to getting this thing done and understand where the creditors stand in the whole argument of consensual restructuring. So I am not happy at all.

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Operator [19]

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(Operator Instructions) And our next questionnaire today will be David Einhorn with Greenlight.

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David Michael Einhorn, Greenlight Capital Re, Ltd. - Chairman of the Board [20]

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I got a couple of questions on Puerto Rico. It sounds like there's a wide range of outcomes through there. I know when you do your reserving, you have to like look at different scenarios and probability to complete them. What do you see is like the worst scenario and the best scenario? And what probabilities do you assign? And how do you think about it from a reserving perspective?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [21]

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Why don't we just invite you to our next reserve committee and you can then sit there and look at all the detail? Honestly, we don't spend that kind of (inaudible) however...

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David Michael Einhorn, Greenlight Capital Re, Ltd. - Chairman of the Board [22]

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I'll be happy to come.

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [23]

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I'll leave it up to my CFO to give the invitation now. But understand, we react -- remember, on GAAP we'll require to do exactly as you described. We've got to basically define all possible scenarios and then probability weight them. Obviously, with each illegal behavior of the government and supported by the control board and the judge, we have to work that factor into our reserving model. The concern we have today is to continue to push out of any possible recoveries. The more they put out plans that show no debt service, we have to then incorporate that into the potential scenarios that are in our model and therefore, move probabilities accordingly. That's why you see regardless of our own personal feelings in terms of how this ultimately works out, the SEC and GAAP do not allow us that freedom to say, no, it's your view, not this analytical scenario model probability weighting. So because in the current quarter, we had another fiscal plan, now that this one is even worse, 0 debt service, we then have to accordingly change what is the basically payout or repayment scenarios that exist and of course this becomes a present value game. And anytime there's movements in interest rates, it's going to affect the present value of, say, recoveries that are back-end weighted versus payments that are front-end weighted. So the reserve is going to change period to period based on news and changing rates, and I think we've been very responsive to reflect all scenarios with a reasonable level of view in terms of possible outcomes.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [24]

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And when we do this analysis, we look at anything that happens within that quarter. If it's positive, then that would affect the positive scenario. We would probably change the probability weight for that. If it's negative, we would increase our more pessimistic scenario and increase the probability weight for that as well. We also analyze, do scenarios still make sense and add scenarios if we think another scenario is appropriate.

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David Michael Einhorn, Greenlight Capital Re, Ltd. - Chairman of the Board [25]

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Great. So I mean, I understand the methodology, and I think that's really all you just spoke to. Can you describe like what you think the worst scenario in your analysis is? And want probability you assigned to that? And what you think the best is? And -- or how many scenarios there are to give some color to that?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [26]

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Yes. Understand, we're in rather intense negotiation. Disclosing any of that information I think really does influence or affect the position at the negotiating table. And therefore, it's never going to be public information, and we don't anticipate making it public information. So I'm sorry.

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David Michael Einhorn, Greenlight Capital Re, Ltd. - Chairman of the Board [27]

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Okay. Let me ask one other question. Can you talk about your initial rating system for Puerto Rico? You rate the GOs on your trouble supplement CCC-. The -- upon seeing you defaulted the regular rating agencies rate them D, what's the difference between your CCC- and a D? And if you move your own rating from a CCC- to a D, would that impact your financial reporting?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [28]

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It would not impact our -- well, I'll put it different way. It won't impact our reserves. When we do this, we'll call this a reserve off model, so it really is not relying on the rating or the probability of that rating closing or default and therefore go into the standard severity by specific category class in the municipal finance. This is an off-model reserve. So none of that has any impact. And obviously, we have to look at the entirety. Remember, we still believe in our legal claims here. So at the end of the day, although the behavior goes in one direction, we believe we have valid legal claims. And obviously, recoveries also affect -- our view of future recoveries affect that overall comprehensive rating. But as I said, this is an off-reserve credit that is done on this other basis not using. In the old days, we used to give ratings probability of default and severity for the asset class. Obviously, we do take specific credits off-line of that model.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [29]

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These are specific models. They're not off-model. They're specific models that we have designed for Puerto Rico. What Dominic is describing is there are some below investment grade credits that would attract reserve through the scenario loss model, which takes frequency and severity of loss based on rating agency statistics. But with Puerto Rico, this would have no effect. It's -- we have discrete models that we've built for them.

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [30]

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Right. They're in a position all by themselves as you can well imagine.

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Operator [31]

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And our next question today is Geoffrey Dunn with Dowling & Partners.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [32]

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Rob, I got a couple to start with you. Just to be clear, that 5 0 5 at the U.S. holdco, that is after the '18 dividend from AGC?

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [33]

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The 5 0 5, you're talking about what's sitting at the holdco?

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [34]

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Yes, I just want to make sure (inaudible)

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [35]

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Yes. That is after we've sent the money up, after what we call the special dividend has come up. All that money is now sitting at the holding company.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [36]

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Perfect. And then I wanted to ask you about refunded premiums. Obviously, there's been a big boost earnings and premium line over the last several years. 10-year anniversary to '08, the tax reform impact. Can you talk a little bit about at least directionally, how do you think refunded premiums could trend versus what we've seen over the last few years? Are we set for a big correction going into '18 and '19?

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [37]

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Yes. And Geoff, I mean, advance refundings were a significant portion of refundings over the last number of years. And you're right, it will -- I think it will have an effect in 2018. So we should see a drop over the year from 2017. How much? It's hard to say. But given that, that came out in December and now municipalities cannot use advanced refundings in the tax exempt market, then we should see a drop. How much? It's too early to tell but directionally, it will be down.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [38]

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Okay. And then can you give a little bit more detail behind your 14% to 16% non-GAAP effective rate? What are some of the nuances that could get you to that level?

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [39]

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It's really based on the fact that AG Re is, obviously, at a 0 tax rate here in Bermuda, and U.S. operating entities, U.S. income will be taxed -- is taxed at 35% previously, now comes down to 21%. When we run our models and we look at the mix of income, we said, okay, U.S. income is going to be at 21%. How much income is going to come from AG Re? And I wanted to give guidance as to what we expect this year between 14% and 16%. But obviously, that could change. It's a mix of business changes and more business is actually in Bermuda, more business -- more earnings are in Bermuda. If more is in Bermuda, that number will go at the lower end of that range. And obviously, if more is in the U.S., it would tend higher between -- higher end of the range of 16%, so that was the main difference.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [40]

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I get the mix. I guess, I'm wondering how the beat plays into this at all.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [41]

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The what? The beat?

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [42]

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Yes.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [43]

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Well, the base erosion, it obviously can be an issue to the extent that we cede a significant amount of business to Bermuda. This -- and that would obviously -- that's almost -- that's a minimum tax. And at this point, we don't see that being an issue for our business plan with 2018. But we will closely monitor that. And as if, in fact, it would become an issue, we could also just how much we cede to Bermuda.

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [44]

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Remember, Geoff, we had a 35% statutory going in, in the past years. And our effective have always been in the 20s, vacillating between low 20s and mid- to upper 20s because of these tax exempts in the U.S. That's why we're moving to 21 now in the U.S. is okay. Somewhere in the teens, we should be once again, using tax exempt securities in the United States.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [45]

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And that's also based on our forecast and our business plan.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [46]

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No, I get that. I just want to make sure there's no curve balls with (inaudible)

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [47]

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And Geoff, before we go on I just want to answer another question that was asked earlier. I just got some information. I mean, we think that the Syncora transaction would be an increase roughly about $0.35 to book value per share. On an adjusted book value, we expect it to be about $2.42 per share accretive to the company. That's our expectation.

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [48]

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Depending on when it closes.

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Robert Adam Bailenson, Assured Guaranty Ltd. - CFO & CAO [49]

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Depending on when it closes.

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Geoffrey Murray Dunn, Dowling & Partners Securities, LLC - Partner [50]

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All right. Dominic, last question. I think the expectation was for the fiscal plan for Puerto Rico towards the end of December and then the OB to look at it by February. What is going on with the Oversight Board right now with respect to reviewing that plan? Has there been any formal pushback or requested revisions? What's the update on that front?

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Dominic John Frederico, Assured Guaranty Ltd. - Deputy Chairman, President & CEO [51]

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Well, obviously, with the letter that all creditors -- basically most of the creditors signed on the 14th of February to the Oversight Board, I don't think -- I think you can conclude that there are no creditors that are accepting the plan as currently filed and therefore, they're trying to put a lot of pressure on the Oversight Board to basically start to get this thing back to some reasonable level of adherence to PROMESA. You saw Bishop has written a letter as well. Congressman Bishop who obviously drafted the current law has stated -- saying that there's got to be a creditor involvement. You've got to go back and respect the constitution priorities and contractual liens. So I think there's coming in from all sides now and on more unified basis. You can always look at, well, it's one creditor I'm arguing against, therefore, how much noise we'll have to pay attention to. But now they have to understand basically, you have all creditors. You can win a battle against one. It's a little hard to win a battle against 50. And I think there is starting to be momentum building up on that side. Number two, you got to remember, the Oversight Board only has 18 more months in their terms. So do we believe there's going to be anything really concrete accomplished, especially the access to the marketplace? Therefore, this could be a waiting game. Swain seems to be making decisions that are kind of delaying the obvious, basically hiding behind Title III. So while Title III prohibits me from forcing them to pay those revenues overdue, okay, fine. That only lasts for so long as we get into an appellate court. So I think there's a lot of momentum pushing back finally, that we've got a unified position by the creditors. I think every inch of behavior of both the government and the Oversight Board has been illegal and ultimately has to be corrected. Obviously, we're going to have rule of law. If -- as I said, contractual rights. If you can imagine, in our financial markets, all contractual rights are retroactively taken away. We then have no longer our financial system in the United States. We have pure chaos. And that's exactly what Puerto Rico wants to do. And once again, we did call the distinction between Guam and the Virgin Islands and Puerto Rico. Like I said, when the hurricane hit Houston, did the Houston Mayor immediately get on television saying I'm not going to pay any of my debt? Absolutely not. Why do we think it's applicable here in Puerto Rico? And if any congressman or senator wants to forgive Puerto Rico's debt, then fine. Do it through the U.S. government. Don't put in -- basically invisible tax on U.S. citizens and voters and taxpayers that happen to own those bonds, let alone the companies that insured them. This is ridiculous, and so it needs to be held accountable for.

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Operator [52]

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And it looks to be no further questions at this time, so this will conclude our question-and-answer session. I would now like to turn the conference back over to Robert Tucker for any closing remarks.

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Robert S. Tucker, Assured Guaranty Ltd. - Senior MD, IR & Corporate Communications [53]

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Thank you, operator. And 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.

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Operator [54]

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And the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.