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MBIA (NYSE:MBI)

Q1 2013 Earnings Call

May 10, 2013 8:00 am ET

Executives

Greg Diamond - Head of Equity Investor Relations

Joseph W. Brown - Chief Executive Officer, Director, Member of Executive Committee and Member of Finance and Risk Committee

C. Edward Chaplin - President, Chief Financial Officer, Chief Administrative Officer, Vice Chairman of MBIA Insurance Corporation and Chief Financial Officer of MBIA Insurance Corporation

William Fallon

Anthony McKiernan - Chief Portfolio Officer and Executive Vice President

Analysts

Mark Palmer - BTIG, LLC, Research Division

Arun N. Kumar - JP Morgan Chase & Co, Research Division

Operator

Good morning, and welcome to MBIA Inc. First Quarter 2013 Financial Results Conference Call. [Operator Instructions] I would now like to turn the call over to Greg Diamond, Managing Director of Investor Relations at MBIA. Please go ahead.

Greg Diamond

Thank you, Maria. Welcome to MBIA's conference call for our first quarter 2013 financial results. For the first segment of our call today, Jay Brown and Chuck Chaplin will provide some brief comments, then Bill Fallon and Anthony McKiernan will join Jay and Chuck for the question-and-answer session.

After the market closed yesterday, we posted several items on our website, including our latest 10-Q, operating supplement and financial results press release. The press release includes the information for accessing the recorded replay of today's call, which will become available approximately 2 hours after the end of the call.

Please note that anything said on today's call is qualified by the information provided in the company's 10-Q, 10-K and other SEC filings as our company's definitive disclosures are incorporated in our SEC filings. Please read our first quarter 10-Q as it contains our most current disclosures about the company and its financial and operating results. The 10-Q also contains information that may not be addressed on today's call. The definitions and reconciliations of the non-GAAP terms that will be included in our remarks today may be found in our financial results press release.

And now for our Safe Harbor disclosure statement. Our remarks on this conference call may contain forward-looking statements. Important factors such as general market conditions and the competitive environment could cause actual results to differ materially from those projected in our forward-looking statements. Risk factors are detailed in our 10-K, which is available on our website at mbia.com. The company cautions not to place undue reliance on any such forward-looking statements. The company also undertakes no obligation to publicly correct or update any forward-looking statement if it later becomes aware that such statement is no longer accurate.

And now Jay will provide some introductory comments. Jay?

Joseph W. Brown

Thanks, Greg. And let me say with a newly refreshed level of enthusiasm, good morning, everyone. It truly is a good morning, and a pleasure to speak with you today.

Although this call is technically about our first quarter results, I think most of you would agree that they are completely overshadowed by events that took place after the quarter ended. Over the past few weeks, we collected our putback recoverable from Flagstar Bank, we settled the putback recoverable and the CMBS exposure and all the litigation between MBIA and Bank of America Merrill Lynch and Countrywide.

We commuted the insured exposure we had to SocGen, bringing an end to the bank litigation over our 2009 transformation as they were the last remaining bank plaintiff. And we negotiated commutations of $1.8 billion of other structured finance exposures, bringing total committed exposures since the end of the first quarter to $13.4 billion.

Chuck will take you through the details on these actions, but I want to focus on their strategic importance. Before I do that, though, I want to clear up one point of potential confusion about the impact of the settlements on our financial statements. The financial statements that we published last night include the economic impact of the settlement with Bank of America as well as these other discrete post-March 31 events. That's because the amounts we received from the putbacks and the amounts we paid out on commutations were totally consistent with the estimated amounts that had already been recorded on our balance sheet. So although the transaction settled in the second quarter, their values were consistent with the net balance sheet positions at March 31, 2013, and will have no impact on our income statement or our statutory capital in the second quarter. The differences between these values and our balance sheet positions as of December 31, 2012, are also de minimis.

Importantly, so far, all the putback recoverables we have collected have been consistent with the amounts we had recorded. The strategic importance of these settlements for your company, however, is far from de minimis. First, we had previously disclosed that if MBIA Corp. did not reach a settlement with Bank of America, the resulting liquidity stress could have caused the regulator to place it into a rehabilitation proceeding. The rehabilitation process would have eliminated any chance of our shareholders realizing any value from MBIA Corp. and most likely would have had a similar impact on our surplus note holders. In addition, while the rehabilitation would not have created a cross default at MBIA Inc., it would have imposed additional risks and costs on the holding companies and would have potentially further delayed the resumption of new business activities at National. That risk has now been reduced substantially as the vast majority of the most potentially volatile payment risks have been eliminated and we now have access to the $500 million Bank of America loan facility. You should think of the loan facility as a bridge to the collection of the remaining of our putback recoverables, which now have a balance sheet value of over $1 billion. We are not there yet as there are still a few parties we need to collect, but that day is fast approaching, and when we get there, the risk of rehabilitation will be reduced to insignificant levels.

Second, the intercompany secured loan from National has been fully repaid and the bank litigation concerning our 2009 transformation has ended. S&P's recent upgrade is another important step in restoring National to its leadership position in the U.S. public finance insurance market, but it won't be an overnight process as there's still a lot of work to be done before National is writing any material volume of new business.

But after more than 4 years of sitting on the sidelines while it built its capital position, National is finally in a position where it can begin moving forward, and I can already feel a very marked increase in the level of energy and enthusiasm among its staff as they prepare to implement their business plans.

Third, the end of hostilities in the courtroom with various parties will increasingly enable us to turn our full attention towards planning and executing the strategic future of your company for the benefit of all of our stakeholders. Investors in both MBI and Bank of America have already recognized the value of our agreement as Monday's closing price suggested about $8 billion increased equity value for the 2 companies.

Before turning the microphone over to Chuck, I'd also like to recognize our remarkable employees. If character is revealed in adversity, our employees have shown that they have grit, loyalty and courage in spades. Our recent successes would not have been possible without all of their efforts. While the management team created a plan, it was our employees who made it happen. It is because of them that I am optimistic about our future. I am grateful to them and to all of you for the support and concern many of you expressed to me over these 4 very long years of litigation.

Now I'll let Chuck provide some more details on the various settlements and our first quarter results.

C. Edward Chaplin

Thanks, Jay, and good morning, everyone. First, I'll walk you through the results through March 31, and then talk in more detail about the commutations and settlements.

Our GAAP consolidated net income was $164 million in the first quarter compared to net income of $10 million in the first quarter of 2012. The driver here is the increase in the value of putback recoverables in the first quarter this year. Our non-GAAP measure adjusted pretax income provides an alternative way to analyze our fundamental business performance. We had adjusted pretax loss of $20 million in the first quarter compared to a loss of $548 million in the first quarter of 2012. The improvement is driven by significantly higher realized investment gains, lower insured losses and much lower -- and lower litigation and legal costs. Our adjusted book value declined modestly from $30.68 at year end 2012 to $30.56 per share at March 31, primarily due to insured losses.

Now a couple of comments about performance at the segment level. The public finance segment conducted in National had pretax income of $142 million compared to $55 million in last year's first quarter. Realized gains on investments were significantly higher than last year and insured losses and litigation costs were significantly lower. The structured finance and international segment operated in MBIA Corp. and its subsidiaries had an adjusted pretax loss of $97 million compared to a loss of $446 million in the first quarter of 2012. The driver of the difference is much lower insured losses, which were $98 million in the first quarter of 2013 versus $402 million in last year's first quarter. Economic losses increased for CMBS exposures by $282 million, primarily reflecting higher expected commutation costs. On the other hand, economic losses for second-lien RMBS decreased. The decrease is driven by a higher value of the putback recoverable, which increased by $384 million.

The increase primarily reflects the recognition of contractual interest in our estimation of collections, making our calculations more consistent with our actual legal claims and with the outcome in the Assured Guaranty v. Flagstar case. An increase in our estimate of future net claim payments on second-lien RMBS partially offsets that higher putback value, and the net of the 2 results in a reduction of economic loss for our second-lien RMBS policies of $146 million.

All other economic losses in other areas of portfolio were reduced by $38 million, primarily as a result of the commutation of a secondary market program. The sum of the CMBS increase in economic loss and decreases for second-liens and for the other sectors taken together result in the $98 million of insured loss in the quarter. The combined pretax loss for our advisory segment, the wind-down operations and the corporate segment was $66 million compared to a loss of $161 million last year. The biggest driver of the difference is that in last year's first quarter, we incurred $128 million of realized losses and impairments in the wind-down operations as a result of an asset sale program.

So now to provide more details on the risk-reduction transactions that took place recently. First and after March 31, we agreed to commute a secondary program with about $1.7 billion of exposure, including CMBS pools, commercial real estate CDOs, ABS CDOs and first-lien RMBS.

Second, we settled our putback collection action against Flagstar Bank for $110 million and other considerations, including the elimination of $100 million of insured par exposure.

Third, we settled with Bank of America. As Jay referenced, the payment that we received represents a settlement of our putback claims net of the cost of commuting the CDS on $7.4 billion of exposure, of which $6.1 billion related to commercial real estate. The amount that we received on Tuesday was approximately $1.6 billion of cash and $136 million par amount of MBIA Inc. bonds. In addition, Bank of America is extending a $500 million loan facility and received warrants to purchase 9.94 million shares of MBI for $9.59 per share. We have agreed to dismiss all litigations between Bank of America and its subsidiaries and MBIA and its subsidiaries.

Fourth, we commuted $4.2 billion of ABS CDO, CMBS pool and CRE CDO exposures with Societe Generale. The bank also agreed to dismiss all transformation-related litigation, which ends those lawsuits. So what are the impacts of these transactions?

First, I'll talk about the impact on MBIA Corp.'s statutory balance sheet. As Jay referenced, because the transactions were agreed upon in the period subsequent to March 31, 2013, but before MBIA Corp. published its statutory results, the March 31, 2013, amounts were adjusted to reflect the agreements. The net effect of the adjustments was to lower statutory capital by an immaterial amount, about $2 million. Basically, as a result of the adjustments, the net of the commutation costs and the putback receipts were the same as the net of the related putback recoverables and case reserves that are recorded to MBIA Corp.'s balance sheet as of March 31.

Furthermore, the net effect of these items on statutory capital as of March 31 was also consistent with the amounts recorded to the balance sheet at December 31, 2012. So with respect to the stat capital effects of these transactions, there was little change in our estimates from year end 2012 to March 31, 2013, and then the March 31 numbers have been adjusted to reflect the economics of the agreements. The adjustments affect the first quarter income statement, but the impact is de minimis.

Beyond that, what will we see in the second quarter? The commutations of the CMBS, ABS CDOs and the secondary program will reduce the statutory case loss reserves on MBIA Corp.'s and its subsidiaries books by $1.5 billion, down to approximately $985 million. In addition, the settlements of the putback litigation with Bank of America and Flagstar Bank will reduce statutory putback recoverables by $2.9 billion, bringing them down to $1 billion. There will be no impact on MBIA Corp.'s statutory capital or statutory earnings from these transactions in the second quarter other than lower legal expenses, lower interest on the secured loan and a small increase in the putback recovery reflecting the difference between the value of the MBIA Inc. bonds when received this past Tuesday versus when we closed the books at the end of the prior week.

The facts -- the financial facts are generally similar for our consolidated GAAP reporting with a couple of exceptions. Because it's consolidated and it looks at the holding company, we've adjusted the litigation expense at the holding company level as of March 31, respecting our agreement to issue warrants to Bank of America. Also, the CMBS is mark-to-market as of March 31 for GAAP reporting purposes and under the accounting rules, that value can't be adjusted for later developments. So because the cost of commuting the CMBS is slightly less than the mark-to-market as of March 31, we will have a small gain in the second quarter from releasing that mark-to-market. In addition, we'll have additional putback recovery relating to the bonds just as I described on the statutory side.

So that's the financial statement impact of these transactions. The settlements will have a big impact at MBIA Corp.'s exposure and potential future volatility. Our first quarter financial supplement shows gross par insured exposure as of March 31 of $107 billion. These commutations will reduce that amount by $13.4 billion or 13%. It will eliminate 5 of the current top 10 below-investment grade credits in the portfolio, and you will see that in detail in our second quarter financial supplement.

We believe that the future potential volatility of statutory capital has been dramatically reduced as a result of the commutations. Also, liquidity will be significantly affected. At March 31, 2013, MBIA Corp. had $258 million of liquidity. Rolling that forward to April 30, liquidity had fallen to $196 million. The pro forma impact of the Flagstar and BofA settlements, as well as the sale of invested assets to the holding company and after paying off the National loan, would bring that balance to $385 million. When we then layer in the cost of the additional commutations, the liquidity balance at MBIA Corp. would be approximately $185 million.

In addition to that resource, of course, we also have access to the loan from Bank of America for $500 million, so total liquidity resources would stand at $685 million on a pro forma basis, more than double the resources at March 31. We believe that this liquidity position is adequate. On our base assumptions about loss payments that are in accordance with our March 31 loss reserve estimates, we will have adequate liquidity to make all payments as they come due with minimal reliance on the Bank of America line of credit. However, if there is extreme stress in the payment stream and the collections of the Crédit Suisse and ResCap putback recoverables are delayed beyond our expected timing, we would need to draw more heavily on the Bank of America line of credit.

We have reported and Jay commented a few minutes ago that we previously expected payments in the short term on the Merrill Lynch CMBS pools and that those payments would very likely be far in excess of MBIA Corp.'s liquidity. The commutation removes that existential threat. So our future expected payments will be much lower than they would have been had we not settled and liquidity resources are significantly higher.

Now there are remaining risks in MBIA Corp.'s portfolio. We remain exposed to future loss development on the second-lien RMBS, including for the Countrywide originated securitizations. We also have to collect the remaining putback recoverables of approximately $1 billion. We are sensitive to both the amount of those collections and the timing. We continue to have exposure to CMBS with about $914 million of exposure to what were originally BBB pools, about $3 billion of exposure to originally A pools and about $3.5 billion of exposure to originally AAA pools. And of course, we have exposure to the macro economy. Another downturn in the future might create problems for our portfolio even though it is well seasoned at this point.

We have also in this transactions commuted away some future installment premiums. The gross undiscounted value of all premiums due to MBIA Corp. was $1.421 billion as of March 31, 2013. The commuted transactions contributed $112 million to that undiscounted figure. So while we won't have that income in the future, we also won't have the legal fees associated with our formerly extensive lawsuit portfolio, which could easily exceed or even dwarf this item.

We believe that these settlements make the risk of regulatory intervention around MBIA Corp. minimal for the foreseeable future. The settlements also have a huge impact on National, which had nearly 1/3 of its investment portfolio in the secured loans. While we had no doubt about the quality of that asset, the rating agencies took a darker view of it, including a 100% capital charge from S&P. The repayment of the loan greatly improves National's capital adequacy on the rating agency models. And the elimination of the various transformation-related litigations removes the other meaningful impediment to higher ratings and a return to the municipal bond insurance market. We have managed to maintain our marketing, underwriting and servicing platform, and we believe that National has unique advantages in its market. We expect to be in a position to write business and add to shareholder value in the near future.

These events affect the holding company as well. To help fund the commutations, MBIA Corp. sold assets from its investment portfolio to MBIA Inc. Those assets are now held in our tax escrow account. To the extent that spreads on those assets widen significantly, this could impair releases from the escrow account, and for reference, the next release is expected in January 2014.

On the other hand, the settlement of the transformation litigation should free National to pay dividends to the holding company, which we expect later this year. At March 31, the holding company had $373 million in liquidity. And together with ongoing expected flows, we believe it is adequate to cover its operating needs, including covering the negative cash flow in our wind-down operations for the foreseeable future.

All of these effects have been discussed with the rating agencies and we're beginning to see the impacts. S&P has now upgraded all of our significant ratings. While we expect that we'll have further discussion with the agencies about our business and capital plans and revised liquidity and capitalization profile, the transactions just consummated or agreed put us on glide path to achieving the ratings targets that we have for National, MBIA Inc. and MBIA Corp.

While the events of the last couple of weeks are very consistent with our expectations, in economic value and in timing, we are thrilled to have delivered on those expectations and to have that work now behind us. We look forward to business planning, execution and financial reporting that's more normal in the future and maybe it will even become boring. Until then, we look forward to your questions about today's report.

Greg Diamond

Okay, Maria. We're ready for questions and answers.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Mark Palmer of BTIG.

Mark Palmer - BTIG, LLC, Research Division

A few questions. First of all, with regard to the SocGen settlement, there have been some media reports about how that settlement is going to be funded. Just wanted to see if you could shed some light on where the cash to pay for the settlement is coming from?

Joseph W. Brown

We can't comment further on the funding.

Mark Palmer - BTIG, LLC, Research Division

Okay. Fair enough. With regard to the process associated with relaunching National, if you could walk through what the sequence of events is going to be and what your thoughts are currently about the timing for a relaunch.

William Fallon

.

Yes, it's Bill speaking. As you can imagine, there are several things we need to do. I think the 3 primary ones are, first, talking about the financial strength of National, which I know Chuck has talked about consistently over time. And that includes the ratings, which also you heard earlier some of the things that have already happened. S&P did upgrade National to BBB and indicated that it would go to A even when the SocGen settlement was reached, which eliminated the litigation that the banks had started 4 years ago. So that's one area and we're working on that right now. Second is just to re-establish all the connections in the marketplace with broadly defined clients. That would include issuers, investors and intermediaries, intermediaries being the banks and broker dealers. And we have maintained relationships all along. And then, third, there may be some need for a handful of additions to the staff, but we are ready to go organizationally and it would just be over time as we start to do business. So hard to predict exactly the timing, in particular with regard to the ratings, but this is something that we've already started working on. We've been working on it even ahead of these settlements. And we look forward to re-entering the market soon.

Joseph W. Brown

I think the biggest obstacle, Mark, which you're probably aware of, is actually the current low interest rate environment creates a limited amount of opportunities in the near term. And so even when we're prepared and have the appropriate ratings that our balance sheet deserves, there is going to be a slow uptick just simply because there's just not going to be that much business that we can create enough value to justify what we have to charge against the capital that we have to put up.

Mark Palmer - BTIG, LLC, Research Division

Just one more. With regard to the expected dividends to the hold co from National later this year, can you give us a sense of what the magnitude of those dividends may be?

C. Edward Chaplin

Yes, we have an as-of-right dividend that at first quarter is measured at about $200 million, and we would expect in the second half of the year to process a dividend. We haven't decided exactly what the amount will be, but the as-of-right amount is about $200 million. And Mark, let me just go back to your first question with respect to the financing of the SocGen commutations. The one thing that I can confirm is that we did not draw on the Bank of America line of credit to enter into that commutation. So that the loan balance there is still 0.

Operator

Our next question comes from the line of Arun Kumar of JPMorgan.

Arun N. Kumar - JP Morgan Chase & Co, Research Division

First of all, congratulations on all of these commutations and settlements. Great job on that front. I have a couple of questions for you. The first one relates to the CMBS below-investment grade and even the ones you referenced to in the A and AAA tranches. Could you give us some context on how that below-investment grade portfolio is behaving in terms of [indiscernible] in terms of loss development, but also in terms of what kind of attachment points do you have on that remaining below-investment grade CMBS portfolio?

Anthony McKiernan

Sure. This is Anthony speaking. We have, as Chuck referenced, a little over $0.5 billion remaining original BBB-rated exposure left. We actually have paid a claim this quarter -- right after the quarter on that exposure. The transaction is actually lumpy from a vintage standpoint and the payment timing, so we would expect that to have sporadic payments over the next couple of years. The A exposure to this point has not reached deductible levels in any material way. The deductibles are very close to what they were when the deals were originally done. General ranges [ph] are around 14% to 15% as far as the deal deductible themselves. And then the AAA exposures are very highly enhanced. We've had very little deterioration or interest shortfalls for that matter in those deals to this point.

Arun N. Kumar - JP Morgan Chase & Co, Research Division

Okay. Just turning back a little bit in terms of MBIA Insurance Corp. Now that you've got the settlement from BofA, statutory capital is -- I mean, the quality of the capital at least has significantly improved. You paid back the National loan. In terms of future commitment from the Enterprise Holding Company to warrant Insurance Corp., if the need arises, I'm not saying that it will, but if the need arises, would Corp. or through National, would the Enterprise still be willing to support or lend funds to MBIA Insurance Corp.?

Joseph W. Brown

In terms of talking about possibilities for the future, we always look at all the alternatives and try and make sense of what makes the most sense for our shareholders and other constituencies. As Chuck went through the details on our current expectations on the base case, we don't even expect to have to need to draw on the BofA facility. And under stress, we would actually have to use it over the intervening 3 years that it's termed out. So I think in that time frame, it's hard to identify a situation where we would even have to contemplate that question. But I can assure you we look at things very carefully each time to try and say what makes the most sense. And we'll make investments or reallocate capital for the best interest of our shareholders.

Arun N. Kumar - JP Morgan Chase & Co, Research Division

Okay. A couple of other questions -- one related to your surplus notes. I think there is a covenant in the BofA bank line that limits your ability to pay the coupon on the surplus notes, do you know at what point would you contemplate in terms of servicing that surplus note down the road?

C. Edward Chaplin

We have an obligation under the surplus notes, Arun, to request interest payments from the regulator each time they are scheduled. We have been doing that; at this point two of them had been denied. The regulator is also aware that there's a covenant in the Bank of America line that says that we won't pay interest or principal on subordinate obligations such as this until the line is paid off. And so the regulator will, we would expect, take that into consideration as they're making their determination about whether to approve surplus note interest payments in the future. So as a practical matter, we're still in the same position. The company's -- the company's financial performance will have to improve and stability will have to improve before the regulator will be comfortable, we think, approving surplus note interest payment. Now we do think that the surplus note holders are far better off with us having arranged this facility and entered into this settlement than they would have been had we not done so. So we do think that they are better off.

Arun N. Kumar - JP Morgan Chase & Co, Research Division

Fair enough. Last question on the putbacks. I think Jay and you, Chuck, both mentioned you have about $1 billion of putback recoverables in your balance sheet with other counterparties. Do you have any time line in which you would like to settle or resolve those issues with those parties?

Joseph W. Brown

Well, our time line is very easy. We'd like to do it tomorrow morning, but that's not going to happen. As everybody is well aware, a significant portion of our putback recoverable is as a result of reps and warranty violations by the 2 subsidiaries of ResCap. ResCap is in an extended bankruptcy. A lot of mediation talks are going on. We don't have a specific forecast in terms of when those talks will resolve or whether they will resolve or whether it's going to be a different outcome. It is possible that if there was a successful mediation and that then courts then were able to move through the process to allow ResCap to finish up its bankruptcy, you could see something very late this year or early next year.

Operator

[Operator Instructions] Our next question comes from the line of Robert Halder [ph] of Hartfield and Advisors [ph].

Unknown Analyst

First, congratulations to everyone on a magnificent job. We really appreciate it. Two questions. One, did I understand S&P's information this week where it seemed to me that they were saying that they would upgrade National to A after a settlement with SocGen, and it seemed timing wise that the settlement information came out about 10 minutes later. So I just want to make sure I understood that it seemed like they were implying that they would raise the rating to A after that settlement, which obviously would be a great thing for us. And the second question is all of a sudden it looks like MBIA Corp. has capital, et cetera, going forward. So even though it was unthinkable a week ago, have you begun to think about a strategy going forward -- a business strategy for that company?

C. Edward Chaplin

In terms of the rating agencies, S&P was aware of the SocGen settlement at the time the release went out. They are under a business objective from the time they make a decision to the time they publish. That's one of the things that as a result of some of the issues with rating agencies 5 or 6 years ago, they don't want any information contained inside for a long time, so they try and meet a very timely schedule. I think that's why they were specific in their release that they talked about the potential of a settlement and the elimination or the ending of the litigation between the bank plaintiffs and ourselves. And so we would anticipate they're reviewing that as we speak. And when they make a decision, if there's a change, they'll put it into the marketplace relatively quickly. In terms of a business plan for MBIA Corp., we have had a business plan for MBIA Corp. We do have plans for it in the future. In the short term, meaning the next few years, we do have other liabilities we would like to resolve and we obviously have a significant amount of collections that we have to make on the 2 or 3 different putback recoverables. I think the time for discussing what we're going to do with MBIA Corp. post those activities will be out a year or so and we'll be glad to discuss those alternatives at that time.

Operator

There are no further questions at this time. I would now like to turn the floor back over to Greg Diamond for any additional or closing remarks.

Greg Diamond

Thank you, Maria. And thanks to all of you who have joined us for today's call. Please contact me directly if you have any additional questions. I can be reached at (914) 765-3190. We also recommend that you visit our website for additional information. The address is mbia.com. Thank you for your interest in MBIA. Good day and goodbye.

Operator

This concludes today's MBIA First Quarter 2013 Earnings Conference Call. You may now disconnect, and have a great day.

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