Dec 1, 2008
Executives
Sabra Purtill - Managing Director, Investor Relations Dominic Frederico - President and Chief Executive Officer Bob Mills - Chief Financial Officer
Analysts
Andrew Wessel – JP Morgan Joseph Marino – Piper Jaffray Mark Lane – William Blair & Company Brian Meredith – UBS
Operator
(Operator Instructions) Welcome to the Assured Guaranty Third Quarter Earnings Conference Call. I would now like to turn the call over to Sabra Purtill, Managing Director, Investor Relations.
Sabra Purtill
Thank you all for joining us this evening for Assured Guaranty’s third quarter 2008 earnings conference call. We appreciate your interest in Assured Guaranty and hope that the change in our call time didn’t cause you too much inconvenience.
We believe that this might be a more convenient time for some of our investors and analysts particularly those located in the Central and Western portions of the US. Our speakers today are Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Limited and Bob Mills, Chief Financial Officer.
After their prepared remarks, they will take questions from the audience. Please note that our call is not web enabled for Q&A, so if you would like to ask a questions please dial our conference call organizer at 1-800-591-6945 and join the call live in order to ask a question.
I would remind you that management’s comments today or responses to questions today may contain forward-looking statements such as statements relating to our business outlook, growth prospects, market conditions, credit spreads, ratings, loss reserves, and other items where our outlook is subject to change. Listeners are cautioned not to place undue reliance on the forward-looking statements made on this conference call today as management does not undertake to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.
You should refer to the Investor Information section of our website and to our most recent SEC filings for the most current financial information and for more information on factors that could affect our future financial results and forward looking statements. I’ll now like to turn the call over to Dominic.
Dominic Frederico
Thanks all of you for your interest and participation in our third quarter earnings call. The last quarter was a continuation of a series of challenging quarters that Assured has had to navigate.
Given this environment I believe our earnings, production, and credit performance were fair although obviously disappointing to us. In particular the credit and liquidity concerns and the global financial market have increased the uncertainty surrounding the future performance of our RMBS portfolio and some other exposures.
This uncertainty leads us to proactively establish loss reserves that take into account an increasingly stressed economic environment in 2008 and 2009. I think it’s important to keep in mind, however, that throughout these difficult times Assured has maintained operating profitability as well as its presence in the market as one of the few highly rated viable options for issuers and income investors.
The company’s well established underwriting and risk management principles have protected us from the credit losses that have impaired the market presence and balance sheets of many other financial institutions. There’s not a day that goes by that I’m not thankful for our decision not to underwrite CDO’s of ABS or other risky securities.
Furthermore, our decision not to expand into business lines within embedded liquidity risks such as financial products or guaranteed investment contracts has protected us from further threats to our ratings and franchise. As you are well aware, several financial guarantors are facing liquidity challenges due to their need to collateralize investment agreements or obligations due to their own rating downgrades and the decline in market value on the assets representing the collateral supporting the debt.
In spite of our many good decisions we are not immune to the fallout from the worst credit crisis to face this country and the world since the great depression. Our principle concern remains our RMBS exposures where we have long been cautious due to the deterioration and underwriting standards that we began to see in 2004.
Much of the early mortgage problems that emerged in 2007 could be attributed to poor underwriting by mortgage originators, inflated housing values, inappropriate loan products, and real estate speculation. We believe that we were quick to identify those risks in our own portfolio as we began talking to investors more than a year ago about the problems in the Heloc sector ahead of our financial guarantee counterparts.
Today we are looking at more traditional sources of housing losses; unemployment and declining household incomes combined with lower consumer confidence. Our revised assumptions resulted in a downgrade of some real estate exposures thereby triggering additional portfolio reserves.
It is important to note that these additional reserves that were generated are still well within the rating agency stress case assumptions for our portfolio. While it’s uncertain how much longer we will continue to see loss reserve development on the mortgage portfolio what I can be certain of is Assured’s conservative underwriting approach to the US RMBS market in 2005 to 2007 provides a natural cap to the potential losses that this asset class will generate.
I remain confident in our ability to weather the mortgage market problems with our franchising tact given our lack of CDO’s of ABS our limited RMBS exposures and the generally high attachment point and contractual terms that we achieve. Conversely the rest of our portfolio continues to perform well and we remain comfortable with these exposures.
About 34% of our portfolio is currently rated AAA or Super Senior and we continue to have the highest rates portfolio in the industry with an average rating of AA- the same level it has been since our IPO in 2004. We have, of course, extended our revised economic assumptions we use in our real estate analysis to our analysis of the remainder of the portfolio which resulted in some downgrades in the structure finance book of business.
You can see those changes as we post all of our direct RMBS and structure transactions along with their internal ratings on our website. We also expect to see some downgrades in the public finance sectors as the economy becomes more stressed.
Although the probability of the fall is relatively limited given the terms and conditions in those transactions and the ability of many of the issuers to revise budgets, advance borrowings or raise revenues to adjust budget shortfalls. I’d like to talk now about what I think are the good points in our quarter.
We were pleased with our new business production given the environment as both our direct public finance and re-insurance production results were up compared to the prior year. While our US public finance production has slowed down from the pace of the first half of 2008 we were still up substantially over the third quarter 2007 production.
We had about a 43.5% market share which is higher than any other financial guarantor. We believe that both market conditions and the announced Moody’s review of our ratings had an impact on our new business volume in the quarter.
However, our conversations with issuers, investors, and bankers during the quarter confirm that investors, particularly retail investors still value the protection and liquidity that bond insurance provides. We did several large transactions in the last few months including a Pennsylvania Turnpike deal the closed last week that was sold principally to retail investors and that benefited from the investor diversification, liquidity, and credit protection provided by bond insurance.
We remain very optimistic that the demand for bond insurance will strengthen from current levels. We recently announced results for October 2008 where we underwrote 61 transactions for $831 million of par up 65% over the October 2007 month.
Our re-insurance segment booked two large facultative portfolio transactions with a major re-insurance client who would recapture two books of businesses that had previously seeded to other re-insurers. As the largest and highest rated re-insurance company in the market today we continue to look for opportunistic transactions of portfolios such as the CIFG transactions that we announced on October 3 and that we expect to close in the fourth quarter.
I think it’s also important to highlight the growth in our earnings model that we’ve built up over the past several years. Our enhanced revenue stream is driven by the buildup of unearned and installment premiums from new business which is then recognized as earned revenues over the life of the insured transactions.
Because of the volume of new business that we’ve written in the last 12 months our year to date total revenues included in operating income are up 46% to $375.1 million on track to perhaps reach $500 million for the full year depending on refundings and other market conditions in the fourth quarter. This compares to only $284 million in 2004 the year of our IPO.
As of September 30, 2008, we have approximately $2.6 billion of unearned premium reserve and future installment premiums about three times the amount we had at year-end 2004. Furthermore we have grown our investment portfolio by 65% since 2004 from $2.1 billion at year 2004 to $3.5 billion today.
This has resulted in a significant increase in investment income due to an annualized 2008 level of about $160 million up more than 65% compared to the $95 million we reported for the full year 2004. The combination of strong new business production and cash flows from operations has resulted in our solid increase in earned premiums and credit derivative revenues and investment income in 2008 despite the difficult times.
I’d now like to touch briefly on the government and regulatory fronts as there’s been a lot of activity recently in Washington and with the New York State Insurance Department while financial guarantee companies participating in TARP and the CPP. First I’d like to make sure that everyone understands that Assured does not need or want to participate in TARP.
Secondly, we do not need to participate in the capital purchase plan as we expect to have other more efficient sources of capital should we need it. We have heard the news that some of the other financial guarantors may seek to participate in the capital purchase plan which may provide them with the ability to maintain their current rating levels.
We don’t believe that their participation would in any way disadvantage Assured as we believe that we will continue to be viewed as a preferred solution for issuers and that we have the financial strength to ensure the confidence of fixed income investors. We applaud any efforts to ensure the financial integrity and stability of the other financial guarantee companies.
However, any assistance should be limited to solvency and liquidity only and should not address the loss of rating and trading values. Finally, I know you are all tired of hearing me talk about Moody’s and frankly so am I.
Ever since the IPO we’ve spent an enormous time talking about Moody’s and our ratings. Today, looking at the competitive and market environment I remain comfortable with the Assured’s ability to continue to offer issuers and investors the benefit of our financial strength, diversified portfolio, financial flexibility, and access to capital.
I hope that all interested parties will continue to focus on the financial strength and stability that Assured Guaranty provides as apparently confirmed by the stable AAA ratings it has from S&P and Fitch. Assured’s history of conservative underwriting has allowed us to avoid most of the highly troubled assets such CDO’s of ABS and CDO’s squared and puts Assured in a position of financial strength and stability to continue to offer the same level of protection into the future.
We will continue to work with Moody’s to address their concerns and to try to convince them that Assured Guaranty Corp. provides investors today with AAA level protection from credit losses in their investment.
One of our key goals ever since our IPO has been to achieve and maintain the highest ratings possible for Assured Guaranty Corp. and we will continue that commitment.
Looking forward we are confident that there will be strong demand for Assured’s financial guaranty product as market liquidity improves and issuers are again able to sell structured finance and other transactions into the public market. We are also confident that once Moody’s review is completed that public finance investors will still recognize the value of the credit enhancement, liquidity, and transparency that the Assured Financial Guaranty provides.
We gained this confidence from our discussion with issuers, investors, and bankers as well as the continuing level of customer inquiry from those markets. We believe that our revenue model provides stability to our earnings during volatile times and that our proactive approach to underwriting and risk management will help assure whether the economic environment that we are facing.
Now I’d like to turn the call over to Bob to discuss our financial results in more detail.
Bob Mills
I’d like to cover some brief highlights of the quarter. Please refer to our press release and financial supplement for further details on our financial position and results of operations.
Operating income which we calculate as net income excluding after tax realized gains and losses on investments and after tax unrealized gains and losses on credit derivatives for the third quarter 2008 was $26 million or $0.28 per diluted share compared to $48.2 million or $0.70 per diluted share for the third quarter 2007. The principal reason for the decline in operating income was that we had a pre-tax loss and loss adjustment expense on US RMBS exposures written in either insurance or credit derivative form of $95.8 million or $0.89 after tax per diluted share.
These losses incurred were largely related to Heloc and other second lien transactions including $52.3 million for two Countrywide transactions underwritten in our direct segment. Our PVP or Present Value of gross written Premiums for insurance and credit derivatives totaled $139.4 million for the quarter down 16% to $165.5 million which we had in the third quarter 2007.
Direct US public finance rose to $67.7 million for the third quarter 2008 compared to $10.3 million for the third quarter 2007 while re-insurance PVP was $57.2 million up from $32.8 million in the third quarter 2007 reflecting two facultative transactions. The overall decline in PVP was due to minimal activity in structured and international finance reflecting overall weakness in the global economy.
Net earned premiums and earned revenues on credit derivatives for the quarter totaled $115.5 million up 105% from third quarter 2007 with growth in both direct and re-insurance. The amount included $31.7 million of refundings in our re-insurance segment a much higher than normal amount due to the refinancing of auction rate securities and other variable rate debt in the US municipal market.
Net earned premiums and earned revenues on credit derivatives excluding refundings were $83.8 million up 62% from third quarter 2007 and reflect the significant increase in new business underwritten over the past 12 months. As Dominic discussed the growth of our business over the past several years combined with the stability of our earnings model gives us a great deal of visibility into future revenue levels.
The source of most of our revenues for 2009 are invested assets and our unearned premiums is already on the books. To further illustrate our earnings model just based on the business that we have on the books as of September 30, 2008, we expect net earned premiums and credit derivative revenues excluding refundings of almost $290 million which you can see on page 15 of our financial supplement.
Consolidated loss and loss adjustment expenses incurred including losses incurred on credit derivatives and consistent with our previous accounting for loss reserves totaled $92.6 million for the quarter compared to loss expenses of $3.8 million for the third quarter 2007. The increase was largely due to the $95.8 million in pre-tax losses incurred for our US RMBS exposures as previously mentioned slightly offset by reserve releases in portfolio maturities in non-RMBS asset classes.
Aside from US RMBS we did not have any material changes in credit ratings on our insured exposures that resulted in any meaningful changes in our loss reserving levels. Our loss expenses for US RMBS on the other hand are very disappointing but not inconsistent with the trends of the economy and other market participants.
Our exposure to the second lien mortgage market including Heloc’s and closed end second is relatively limited, only $2.3 billion at September 30, 2008, or only 1% of our total net par outstanding and largely concentrated in two direct transactions that we did with Countrywide which provides investors with a great deal of transparency. The increase in our loss reserves for the Heloc and closed end second lien book resulted from specific case loss reserves on some direct and re-insurance Heloc and closed end second exposures as well as rating downgrades on some other RMBS transaction due to a combination of delinquency trends and the deteriorating economic environment.
I would note that we currently include in our assumptions a modest benefit for repurchases by originators for improperly underwritten loans but it is a small percentage of the total amount of loans that we have submitted to the originators for repurchase to date. We will continue to review portfolio loans that did not meet the underwriting reps and warranties and we’ll put those loans back to the originators for repurchase, that the timing and ultimate amount of any repurchase of payments is uncertain.
We have in fact begun to receive payments for repurchase very recently. I would note that to date we have not filed legal claims against any originator, although that course of action we would consider if we need to.
The overall credit environment for a guaranty portfolio has continued to be quite good given the generally poor credit conditions market wide. During the quarter our closely monitored credit list increased by $588 million principally due to mortgage related exposures in both segments that we’ve already discussed as well as three student loan transactions from our re-insurance segment.
The student loan transactions were re-insurance transactions done in prior years and were added because of interest shortfalls related to failed auctions which have occurred market wide and not due to changes in delinquency patterns in the loans themselves. Also please note that our category three CMC exposures increased by $1.2 billion as we downgraded both Countrywide Heloc transactions from CMC2 to CMC3 and established case loss reserves for those exposures.
Quarterly operating expenses increased by 9% net over the third quarter 2007. The increase in operating expenses is due principally to higher headcount than in the prior year’s period.
For the fourth quarter 2008 I expect operating expenses to increase by approximately 3% net over the prior year period as we’re working to maintain our cost discipline. Finally, this quarter we had a net unrealized loss on credit derivatives which was principally associated with downgraded US RMBS securities and wider credit spreads for insured exposures across almost all markets that was offset by further widening of our own credit spreads.
As we’ve stated in the past these mark to market changes in our financial guarantees written in credit derivative form are not a reflection of our expectations of gains or losses on securities that will ultimately be realized. These contracts are generally held to maturity and the gains or losses will dissipate as transactions approach maturity absent any credit default.
We believe it is more informative to analyze our results excluding these unrealized gains or losses. As of September 30, 2008, we had cumulative net losses on credit derivatives a fair value gain on Assured Guaranty Corp’s committed capital securities and accumulated other conference of losses on our investment portfolio totaling $268 million or $2.95 a share which means that our book value excluding this amount is about $25.93 a share a 1% increase over the last 12 months while our adjusted book value excluding the $2.95 amount is about $42.47 an increase of 2% over the past 12 months.
Please note that we plan on filing our 10-Q tomorrow, Friday, November 7. With that I’d like to turn the call over to the operator to poll for questions.
Operator
(Operator Instructions) Your first question comes from Andrew Wessel – JP Morgan
Andrew Wessel – JP Morgan
Looking at the credit migration that you saw your internal ratings on Alt-A and sub-prime RMBS it looked pretty significant everything that’s getting captured now in the single A and lower category. Especially for the non-investment and below investment grade stuff how much of that was captured in the reserving this quarter or actually it would be more the CDS mark to market there.
Dominic Frederico
Remember of the CDS mark to market that we look at separately from real credit impairment. If you look at Alt-A predominantly what you’ve seen is a migration from the AAA and the Super Senior down into the AA, AA-, A, with some migration in terms of the below investment grade or down to the BBB.
I think we’re trying to keep in step with what we see happening in the market and projecting that 2008 and 2009 we’re delaying the economic recovery and as you know in our world of how we reserve once we do that it automatically kicks off the portfolio reserves which are included in the total reserve position that Bob had talked about.
Bob Mills
One clarifying point on the reserve amount that you had mentioned so that we can display any credit impact of credit derivatives actually the number that I quoted is a combination of two losses, loss and loss adjustment expense line of $82.5 million plus the incurred losses of credit derivatives of $10.1 million so that’s where you get the credit aspect of what comes through on the CDS line.
Dominic Frederico
Fundamentally as we move things into our CMC list or downgrade them remember they are still in our view a high probability that there will be no loss realized however, based on our reserving methodology there is a portfolio reserve created.
Andrew Wessel – JP Morgan
The other question I have was based on really just looking out and seeing how the markets responded to you folks being put on review for downgrade by Moody’s. Obviously that had an impact this quarter but it seems like you still had pretty decent production overall.
Is assuming that maybe if the markets looking through to Moody’s and saying maybe Moody’s is looking at a AA whereas S&P and Fitch would still be a AAA. Do you feel like the reception in the market is still there for you that production this quarter is somewhat emblematic of the markets reception to you despite the ratings loss or do you think really the lot effort came right before the Moody’s announcement then it really trickled off post that?
Dominic Frederico
A good question, a little hard to answer. I think there’s so much uncertainty and so much concern in the market that it’s really hard to establish a trend.
As we look at our activity over the quarter obviously we had a significant setback at the onset of the Moody’s announcement because I think general panic ensues and they’re saying okay where does this ultimately end and is it the same spiral that we’ve experienced on behalf of other guarantors. If you look to the balance sheet, if you look to the exposures that we’re very public and transparent about we just don’t have the size numbers and we definitely don’t have the exposure to those highly volatile and highly leveraged transactions that would cause those kinds of significant losses.
As you can see we’re still reporting an operating profit even in spite of having to absorb what we consider a catastrophic meltdown in the real estate market now into the general economy. That was the first setback so then we started to recover and we internally report every day our activity in the public finance market so we’re all thinking good comfort then Lehman goes bankrupt and the same level of uncertainty and panic hit through the markets and once again we lose about another three or four or five trading days until that gets digested and then once again the activity starts to pick up witnessed by that Pennsylvania Turnpike deal that we did in the last week.
Then you have the AIG overhang. I think the market wants to do business, needs to do business, values the guaranty, has confidence in Assured but it still has to digest these market disruptions that continue to take place.
We’re obviously certain that once and when Moody’s comes to a decision if its adverse you’re going to have that same market setback until such time as the market can digest, get comfortable and then once again activity emerges. We think activity has got to get better because there’s just too much financing that’s not being accomplished that for this economy to continue to operate is going to have to ultimately go through the securitization and the insurance marketplace.
We’re hopeful that we’re seeing the worst of the experience relative to production activity and as I said trying to set aside Moody’s and not making a value judgment on what the market thinks of their activity to date. There is going to be continued acceptance and opportunity and as we continue to trade through all the issues that exist out there we’re confident in that and we’re pleased with the results that we put up for the current quarter.
Operator
Your next question comes from Joseph Marino – Piper Jaffray
Joseph Marino – Piper Jaffray
I think you mentioned you had revised your economic assumptions. Could you give us some detail on that?
Dominic Frederico
As we look out one of the things as you’re in a market dislocation first you’ve got to predict the depth and severity of the dislocation then you’ve got to predict its duration and then you’ve got to predict its method of recovery or the slip of its recovery. What we’ve basically done is stretched everything out so as we anticipate the peaking and dropping of delinquencies will result in loss curve everything is extended out so you’re trapping losses within the area of loss recognition and you’re extending forward the potential recoveries.
Remember the deals are all structured you have collateral; you have certain other rights to cash streams so all of that gets factored in. The extension causes the loss and that’s what reflected and the sad part of this I’ve said is that the challenge is because its real estate and most of our issues are in the home equity lines of credit all of your remedies or offsets are really back end loaded.
As you extend out that curve of recovery once again it gets harder to predict what is going to be the beneficial stream. Since we do everything on a net present value basis its discounting back at a smaller number so all of that tends to result in a higher loss reserve which is exactly what we posted in the quarter.
We would have thought we had a recovery somewhere in mid to late 2009 we’re now pushing it out beyond that.
Joseph Marino – Piper Jaffray
Your reserves, your L&LE went up pretty good in the quarter compared to last quarter a little bit more than double. It doesn’t sound like your economic assumptions have worsened to the extent that you provisioned for reserves during the quarter, is that what that’s reflecting part of the discounts that you just mentioned and how do you reconcile that?
Dominic Frederico
I think the economic assumptions have worsened as I said if we look at a flattening and decreasing of delinquencies and default curve which in effect equates to losses in the real estate side as we now push that out an additional six months you’re creating a lot more loss under the curve. That’s what’s reflected in the reserves and were posted.
Delinquencies have decreased but they haven’t decreased in enough of a way that really has started to fully shape the loss curve. The top of the curve is looking more like a plateau and we now have to extend our loss projections across the plateau and extend out where we think the ultimate dropping of the delinquencies in there for the reduction or losses will occur.
As I said, that also pushes out the recognition of the recoveries through excess spread, through draws, though reps and warranties so therefore all of that adds up to as you’re pointing out a significant loss increase or loss provisioning in the current quarter.
Joseph Marino – Piper Jaffray
Regarding the Countrywide transactions what percentage of those are now reserved for?
Dominic Frederico
The total outstanding if we look at 05’ is $545.8 million and we have reserves that would equate to about; $545 million for ‘05, its $648.8 million for ’07 and the total incurred losses which doesn’t mean the total losses we expect to emerge because remember the offsets are $94 million roughly a net 7.9% reserve but you have to add back to get to the full loss provision that we’re expecting in those securitizations the excess spread, the future draws, the subordination we had at the beginning of the deal as well as the put backs in terms of reps and warranties. It’s a net, net, net position.
Joseph Marino – Piper Jaffray
Back to Moody’s do you feel that hypothetically speaking a downgrade by Moody’s bears less of an impact on the re-insurance business as opposed to your direct business?
Dominic Frederico
It depends on what they do with the re-insurance company. One of our issues has been other re-insurance companies have a very different portfolio than the direct company and once again put them into the same situation as the direct company we didn’t think was quite proper at the beginning.
The re-insurance company has portfolio opportunities basically they’re taking portfolios from further lower rated companies so the rating arbitrage or the ratings value still exists. Obviously they have the capability in terms of servicing and holding the business on a go forward basis.
A downgrade hurts everybody and to try to apportion it who gets hurt worse it’s a little bit more difficult.
Joseph Marino – Piper Jaffray
Can you give some commentary on the environment overseas, international business?
Dominic Frederico
The international business is recognized by the production of zero in the quarter is basically frozen. There is no activity; there is a lack of any deals coming to the public market.
They’re being held on balance sheet today which we obviously believe creates an opportunity for the future as well as large infrastructure projects are being delayed as well. That’s going to be a market opportunity that we hope to see in the probably 2009 and maybe mid to late 2009 is those markets themselves are going through tremendous liquidity issues and financial concern.
Operator
Your next question comes from Mark Lane – William Blair & Company
Mark Lane – William Blair & Company
On the two Countrywide transactions in the past you’ve been willing to estimate what you believe your stress test case worse loss case scenario would be are you still willing to do that?
Dominic Frederico
I’ve got about 18 people writing on a piece of paper we now have established a case reserve on an accounting basis that represents our best estimate of what we think our exposure is for those two securitizations.
Mark Lane – William Blair & Company
I know it’s your best estimate but I’m assuming you also have a stress test case.
Dominic Frederico
We have stress test cases that would be a lot lower than that number as well as other cases that would be higher than that number. I would say we have cases that show a lower number to a greater extent than we have a higher number if that makes it comfortable for you.
Mark Lane – William Blair & Company
The public finance business that you’re doing is there any consistency in the type of issuer or the type of deal or banks that are bringing you the deals or is it just completely random?
Bob Mills
As far as numbers done in the quarter like we did 316 deals during the quarter 287 of those deals were general government deals and then beyond that there were a smattering of other deals in the public finance sector. In other words certainly a couple of sizeable deals with Louisville and the Twins Fall Park.
Substantially general government deals.
Dominic Frederico
Its typically the smaller issuers that obviously would not be able to go out on an uninsured basis and the fact that the insurance still provides them access but also ultimate finance savings. That’s the guys obviously you’ve seen enough press about the bigger states or the higher rated guys that have been going out on an uninsured basis or in some cases using a letter of credit as a liquidity support feature to get the deal done.
The nice thing we take away from that is if you look at letters of credit and the amount of enhancement that we’ve been able to do plus the rest of the market there’s still a significant percent of the market that needs some level of credit enhancement and we believe obviously the letter of credit market has a limited applicability and capacity such that we should be able to respond further and further in terms of penetration opportunities on an insured basis in the public finance market.
Mark Lane – William Blair & Company
Would it be your guess that these smaller municipalities that that demand would seem to be pretty consistent even if you were downgraded to AA?
Dominic Frederico
It’s a very resilient demand it’s done in a competitive bid market which as we’ve talked about probably a quarter ago we had moved additional resources to make sure that we were more involved in that marketplace. The second thing we’re going to tell is we still, as we talked in our brief comments we expect to see stress in the public finance markets and we expect to see downgrades there which would once again call for increase in the demand for insurance.
Mark Lane – William Blair & Company
That downgrade comment about the Moody’s is that mean to send a message that to expect higher loss provisions in next year as you start to see downgrades there as well?
Dominic Frederico
No obviously in our methodology which obviously is subject to the new accounting laws it would have theoretically generated a portfolio reserve but we are still quite optimistic that those municipalities tend to have the opportunity to resolve their issues. Remember in this market severities are very, very low so even if you have an eye on higher incidents of potential downgrades the severities are not significant.
With the ability to reschedule the lay as well as secure advance funding they typically can work these things out but it does hit to the need for more insurance.
Mark Lane – William Blair & Company
The automatic reserving impact from the downgrades you’re saying is?
Dominic Frederico
Small.
Operator
Your next question comes from Brian Meredith – UBS
Brian Meredith – UBS
I noticed that in your public finance area and the non-investment grade you’ve now got this other public finance that’s got a decent size there. Can you explain what is exactly in there?
Dominic Frederico
We know that Jefferson County is in there. We had three student loan deals that we did for re-insurance back a few years ago that they were auction rate securities based on the failed auction and the higher interest rate that they’ve had to now pay.
There is a negative carry between the underlying loans and the interest on the debt and therefore we internally downgraded it and that’s what is popped in there it’s about $340 million. They’re government guaranteed loans that’s why they’re considered public finance.
Bob Mills
I don’t think we really think there is a great deal of exposure there but because of the nature.
Dominic Frederico
Because of the negative carry we downgraded it internally.
Brian Meredith – UBS
In your discussions you’ve had with Moody’s over the last couple of months do you think the reserve you put up this quarter will be a surprise to them?
Dominic Frederico
Not at all.
Brian Meredith – UBS
All the issues that we’re getting right now with ant back and the downgrade what impact do you think that’s going to have on your potential business going forward just as investors eventually continue to lose confidence in the municipal bond insurance industry?
Dominic Frederico
I don’t think there is a continued loss of confidence. I think the activity of today is just a continued play out of the sorry situation that has happened relative to some of the guarantors in our industry.
We can all argue about the timing and whether it was anticipated or not but I think if you look at some things like their ability to trade the value of the stock etc. I think there were indications that there were severe problems and whether these problems are the manifestation through a ratings process or not I don’t think the market is at any difference of opinion whatsoever.
Brian Meredith – UBS
Capital management tier you probably do want to wait until the Moody’s decision but obviously with the stock where it is its pretty attractive investment here.
Dominic Frederico
It’s an attractive investment on behalf of everyone especially if you listen to Bob’s adjusted book value be that as it may. The one thing we’re obviously being very conservative about is everyone’s being residential loss forecast or downgrading more instruments.
Although we think we’re pretty proactive in our downgrade process as I said we call our surveillance guy Dr. Know.
That still does generate capital and we want to make sure that we’re protected relative to an increase in capital requirements.
Operator
There are no questions at this time. I would now like to turn the call over to Sabra Purtill for closing remarks.
Sabra Purtill
Thank you all today for joining us. We appreciate your interest in Assured Guaranty and if you have any additional questions or require further information please feel free to contact me either by email or by phone.
Thanks again and have a good evening.
Operator
This concludes today’s presentation.