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Loews Corp. (NYSE:L)

Q2 2010 Earnings Call

August 2, 2010; 11:00 am ET

Executives

Jim Tisch - Chief Executive Officer

Peter Keegan - Chief Financial Officer

Darren Daugherty - Director of Investor Relations

Analysts

Robert Glasspiegel - Langen McAlenney

Michael Millman - Millman Research Associates

David Adelman - Morgan Stanley

Josh Class [ph] - Manikay Partners

Operator

Good morning. My name is Jackie and I will be your conference operator today. At this time I would like to welcome everyone to the Loews second quarter earnings conference call (Operator Instructions)

I would now like to turn the call over to Darren Daugherty, Director of Investor Relations. Please go ahead sir.

Darren Daugherty

Thank you Jackie. Good morning everyone. Welcome to Loews Corporation’s second quarter 2010 earnings conference call. A copy of the earnings release maybe found on our website at www.loews.com. On the call this morning are Jim Tisch, the Chief Executive Officer of Loews and Peter Keegan, the Chief Financial Officer of Loews.

Before we begin, I’d like to make a few brief disclosures concerning forward-looking statements. This conference call will include the use of statements that are forward-looking in nature. Actual results achieved by the company may differ materially from those projections made in any forward-looking statements. Forward-looking statements reflect circumstances at the time they are made and the company expressly disclaims any obligation to update or revise any forward-looking statements.

This disclaimer is only a brief summary of the company’s statutory forward-looking statements disclaimer. We urge you to read the full disclaimer, which is included in the company’s 10-K and 10-Q filings with the SEC.

I’d also like to remind you that during this call today we may discuss certain non-GAAP financial measures. Please refer to our security filings for a reconciliation to the most comparable GAAP measures. After Jim and Peter have discussed our results, we will have a question-and-answer session.

I will now turn the call over to Loews Chief Executive Officer, Jim Tisch.

James Tisch

Thank you Darren and good morning and thanks all of you for joining us on our call today.

For the second quarter, Loews net income increased to $356 million from $340 in the second quarter of 2009. This increase reflects an investment gain of $1 million this year, versus a net investment loss of $178 million in the second quarter of 2009. Loews reported income before the investment gains and losses was $365 million versus $518 million in the second quarter of 2009. This decline is primarily the result of decreased earnings from Diamond Offshore, CNA and HighMount and a lower investment incomes from Loews trading portfolio.

CNA reported overall solid operating and financial performance for the second quarter, although it’s net operating income declined versus the prior year quarter. The primary drivers of this decline was decreased limited partnership results and decreased current accident year underwriting results, which were partially offset by favorable net prior year development.

Subsequent to the close of the quarter, CNA announced an agreement to transform its legacy asbestos and pollution liability for National Indemnity, a subsidiary of Berkshire Hathaway. We believe that this transaction will effectively eliminate CNA’s asbestos and pollution reserve risks, as well as any reinsurance dispute and credit risks.

In the past, our earnings conference call has given me an opportunity to do a quarterly lectures theory on current topics in insurance accounting, and I consider the proposed changes to the accounting rules proposed by the FASB to be a worthy topic for today. On May 26 the FASB published an exposure draft of an accounting standards updates that would significantly change mark-to-market accounting rules for insurance companies and other financial institutions.

The proposed rule changes would require insurance companies to mark substantially all of their investments to market each quarter through the income statement. Fluctuations in the market place of new securities would therefore flow through both the quarterly income statement and balance sheet, instead of just the balance sheet as now occurs under the current rules. Importantly this new methodology would apply to securities currently classified as available for sale.

So let’s examine the impact of the proposed rules on CNA’s reported earnings during the tumultuous market conditions of 2008 and 2009. If the proposed rules had been in effect in ’08, Loews and CNA would have recognized through the income statement, additional investment losses of approximately $5 billion. When CNA’s portfolio recovered in value in 2009, the proposed rules would have resulted in investment gains along those $5 billion being reported on the income statement.

From ‘08 to ’09, Loews’s and CNA’s reported results would have swung by $10 billion, when in our view not much had really changed with respect to the underlying insurance business. The problem with the expanded use of mark-to-market accounting, is that this methodology does not reflect the way an insurance business is run; the way that we and other insurance managements think about or manage our businesses.

The wild and unpredictable swings in unrealized investment gains and losses, will oftentimes draw out the business’s underwriting results and net investment income, notwithstanding the insurance company’s ability and intent to hold the investment security through recovery. While the stated goals for these rules is to enhance transparency, mark-to-market will prove the opposite, by obscuring and camouflaging the underlying operating results.

If these new accounting rules are imposed, I predict that the first thing a security analyst will do when an insurance company announces its results, is adjust the reported earnings for the unrealized investment gains or losses to get to the underlying operating income number, as it is currently reported under existing accounting rules.

The commentary for the FASB’s proposed accounting standards update extends through September 30. I encourage you to send your cards and letters and if you want to get with the 21st century, your emails as well, to let them know that the proposed rules do nothing to improve transparency and they do a lot to obscure operating results.

Now back to our regularly scheduled program. For the second quarter, Diamond Offshore reported a reduction in revenue that was largely the results of a decline in renewal contract dayrates from peak levels and a decrease in overall average fleet utilization. Given these factors, along with the continuing uncertainty caused by the drilling moratorium in the US Gulf of Mexico, Diamond has announced a reduction in its quarterly special dividend.

Its regular and special dividends payable in the third quarter were reduced to a total of $0.875 from the total of $1.50 in the prior quarter. Diamond stated that it felt that it was prudent to retain cash to maintain financial strength and strategic flexibility, as well as to position itself for potential rig acquisition opportunity.

In July, Diamond announced the sale of its high specification jack-up rig, the Ocean Shield to ENSCO for $186 million. This rig is currently working for Apache Corporation in Australia under a term contract, which ENSCO will assume. This was a one-off, opportunistic transaction that Diamond made in order to increase its funds for potential investment in deep water assets such as last year’s purchase of the Ocean Valor and the Ocean Courage.

Loews finished the quarter with holding company cash and investment of $3.4 billion. During the quarter, we repurchased one and a half million shares of our common stock, which is considerably less than our share repurchases in the prior three quarters. While we typically do not comment on the factors that guide our decision to buy back our stocks in any given quarter, I will point out that CNA's discussion with national indemnity, regarding the loss portfolio transfer transaction prevented us from repurchasing our stock during much of the quarter. Absent that factor, the total would probably have been higher than the 1.5 million shares purchased.

And with that, I will now turn the call over to Peter Keegan our Chief Financial Officer. Pete.

Peter Keegan

Thanks Jim and good morning everyone. For the quarter, earnings per share improved $0.87 from $0.78 in the prior year quarter, primarily as the result of realized investment gains at CNA, compared to investment losses in the prior period. Offsetting this were a decline in results with three of our subsidiary companies, and a decline in holding company investment income.

Book value for Loews common share increased to $43.53 as of June 30, from $39.76 at the beginning of the year. For the quarter, realized investment gains at CNA totaled $12 million after tax and non-controlling interest, versus realized investment losses of $178 million in the prior year quarter. The driver of improvement was a reduction in other than temporary impairment losses.

CNA’s contribution to Loews net income before investment gains and losses decreased to $247 million for the quarter from $277 million in the prior year quarter. The decrease resulted mainly from lower investment income, which included a significant decrease and limited partnership results, versus the prior year period, in which CNA recorded exceptional limited partnership investment results.

CNA’S results for the quarter benefited from a favorable net prior year development in its core property and casualty operations. For second quarter combined ratio for PNC operations was 89.4 compared with 98.1 in the second quarter 2009, with the difference primarily attributable to 18.4 points of favorable prior year development. CNA has reported favorable prior year development for 14 consecutive quarters, reflecting disciplined underwriting and reserving practices.

In his comments, Jim mentioned that CNA has entered into an agreement with National Indemnity, under which CNA’s legacy asbestos and environmental pollution liabilities will be reinsured. The closing of the transaction is expected to occur in the third quarter of 2010, at which time Loews expects to recognize a loss of approximately $340 million after tax and non-controlling interest.

Diamond Offshore’s contribution to net income for the quarter declined to $104 million from $181 million in the second quarter 2009. Compared to the prior year’s second quarter, operating revenues decreased by $111 million to $812 million, while contract drilling expense increased by $43 million to $349 million.

The decline in revenue primarily relates to a decrease in day rates and an overall decrease in average utilization from 80% during the second quarter of 2009 to 76% for the second quarter of 2010. This increase in operating expense is primarily due to the addition of the Ocean Courage and Ocean Valor to Diamond’s fleet, as well as higher amortized mobilization expenses and higher operating costs from rigs exiting the US Gulf of Mexico to operate internationally, where the operating cost structure is generally higher.

HighMount reported second quarter net operating income of $5 million versus $29 million in the prior year quarter. During the quarter, HighMount completed the sale of exploration and production assets located in the Antrim Shale of Michigan and the Black Warrior Basin in Alabama. HighMount’s remaining natural gas exploration and production operations are primarily located in the Permian Basin in Texas.

Compared to the second quarter of 2009, HighMount’s operating revenues decreased by $42 million to $105 million. The sale assets in Michigan and Alabama decreased revenues by $24 million, and the reduction in drilling activity in the Permian Basin, as well as lower average prices decreased revenues by $19.

Aside from discontinuing hedge accounting on derivative positions, no significant investment gains or losses were recognized from the sale of HighMount’s Antrim Shale and Black Warrior Basin assets. Because HighMount utilizes the full cost method of accounting, no gain or loss is recognized on the sale of reserved and sales proceeds reduce the capitalized cost pool.

During the quarter, HighMount’s aggregate production volumes for Permian Antrim and Black Warrior assets are as follows: Natural gas production of 15 billion cubic feet, at an averaged realize price of $5.19 per 1000 cubic feet. Natural gas liquids production of 738,000 barrels at an average realized price of $33.20 per barrel, and oil production of 68,000 barrels, at an average price of $71.08 per barrel.

HighMount’s production volumes for the Permian Basin are as follows: Natural gas production of 12.4 billion cubic feet, natural gas liquids production of just under 738,000 barrels, and oil production of 60,000 barrels. As of June 30, HighMount had hedges in place for approximately 79% of its estimated 2010 natural gas equivalent production, at an equivalent price of $6.26 per mcfe and 60% of estimated 2011 production at an equivalent price of $6.32 per mcfe.

Boardwalk Pipeline’s contribution to net income for the quarter increased to $21 million from $8 million in the prior year second quarter. Versus the prior year second quarter, revenues increased by $55 million to $256 million, primarily due to pipeline expansion projects. These increases were partially offset by a $10 million decrease in interoperable and short-term firm transportation services, caused by the lower basis spreads between delivery points on Boardwalk Pipeline’s pipeline system.

Operating expenses in the quarter increased by $15 million to $165 million, primarily from an increase in natural gas prices and consumed fuel related to the pipeline expansion. In the second quarter, Loews Hotel’s net income increased to $4 million from $3 million in the prior year quarter. Revenue per available room increased to $152.82 from $139.21 in the second quarter of 2009. Occupancy for the quarter also increased to 73.6% from 69.8%.

As of June 30, holding company cash and investments totaled $3.4 billion. During the quarter, we received $200 million in dividends and interest from our subsidiaries who purchased 1.5 million shares of our common stock for $56 and we paid $27 million of dividends to our shareholders.

Now, I’ll turn the call back over to Darren. Darren.

Darren Daugherty

Thank you, Pete. Operator at this time we’ll open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Bob Glasspiegel with Langen McAlenney

Robert Glasspiegel - Langen McAlenney

Thank you for your monolog on accounting. I testified at FASB against realized gains and losses going above along the income statement a long time ago, and I can tell you, they seem to have very little interest in usability and functionality for insurance investors and their thought process, so I am pessimistic that you’ll be able to change their thought process, but I agree with the intent and your prediction of what will happen is certainly right on.

James Tisch

Rob, if you want to pessimistic then don’t send your cards and letters. If you want a chance of changing it, then let your voice be heard, because my guess is that a lot of tabloids [ph] are expressing their opinion loud and clear to the FASB, but investment professionals who are actually responsible for managing money and doing serious published investment analysis are not being heard, and those are the people that really need to communicate with FASB.

Robert Glasspiegel - Langen McAlenney

Okay. On Diamond, are property starting to float around yet or is this just a prediction for the future. Is there much traffic of the inventories yet?

James Tisch

I assume you are talking about rigs available for sale.

Robert Glasspiegel - Langen McAlenney

Right.

James Tisch

The for-sale signs are not ours. But having said that there are indicators that seems to be signaling that rig transactions will take place over the next six months to a year. First of all day-rates are down significantly from their peak, there are a number of rigs floaters that are in the yard scheduled to come out of the yard that don’t have contracts.

There are many rigs where the owners are highly levered and now this latest event, the blow out in the Gulf of Mexico, that I believe has sent fifth and sixth generation rig rates down yet even lower. And so all of those factors lead me to believe that, as I said over the next six to twelve months there will be rigs that become available for sales.

Robert Glasspiegel - Langen McAlenney

Will Loews be willing to commit more money to Diamond if there was an opportunity that was too big for Diamond itself to finance.

James Tisch

I don’t know. I will never say never, and I don’t like answering hypothetical questions. What I should say is that Diamond has already bought two rigs. With the current dividend policy, Diamond will continue to accumulate significant amount of cash and my thinking, and I think the Board of Diamond, their thinking is that Diamond will have the wherewithal to be able to make acquisition on their own without any outside help.

Robert Glasspiegel - Langen McAlenney

Okay last question. Is HighMount’s quarter sort of representative of the run rate of current earnings or is there something -- I know there is seasonality as well, but just looking at the year over year trends, as we look for, if the current status of the markets continue for rough comparisons.

Peter Keegan

It’s a function of what our drilling program going forward is going to be. So, I don’t think – and you don’t know what that is and we are not going to state what that is. We are not going to make projection going forward. So, I wouldn’t assume that this is necessarily a run rate. Obviously Bob there is also noise in the quarter for the departure of the Michigan and Alabama assets.

Robert Glasspiegel - Langen McAlenney

There was cost for the disposition.

Peter Keegan

You just have the noise of the revenue decline, because those assets left in the quarter. We totally settled out in the third quarter.

Robert Glasspiegel - Langen McAlenney

Okay, I think I understand your answer. Thank you.

James Tisch

Thank you. And don’t forget, send your cards and letters.

Operator

Your next question comes from the line of Michael Millman with Millman Research Associates.

Michael Millman - Millman Research Associates

Thank you. A sort of follow up on the last, the company’s $3.4 billion, it doesn’t appear that at this point -- well maybe, I should ask this question. Do you see any of the subs needing, maybe need is too strong, using some of the company’s $3.4 billion?

James Tisch

Look, each of our subsidiaries, their marching orders are to finance their own capital needs. And what happened in ‘08 were really extraordinary events, and I would expect that only in very, very extraordinary times will the subsidiary need to come to the parent hat in hand looking for financing. Otherwise, for the public subsidiaries we expect them to finance themselves.

Michael Millman - Millman Research Associates

So, is it fair to say then that cash will accumulate until the company finds some outside investment?

James Tisch

Yes, we’ve said before, we obviously hold some cash in reserve just because you never know what’s going to happen in this world, but we have cash in excess of that reserve amount that we feel even that can be used to repurchase shares, that can be used to buy other assets, either companies or individual assets. Or it can just stay and accumulate on our balance sheet. We don’t let it burn a hole in our pockets.

Michael Millman - Millman Research Associates

And regarding the hotel RevPAR, if I got the right numbers, it looks like it was up about 10% and yet the earnings were up very little. Was there something else going on?

Peter Keegan

Nothing material to talk about, no.

Michael Millman - Millman Research Associates

Is there any reason for us to believe that if RevPAR was up 10%, earning should grow better than $1 million?

Peter Keegan

There is nothing extraordinary to talk about.

Michael Millman - Millman Research Associates

Okay, thank you.

Operator

Your next question comes from the line of David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Good morning.

James Tisch

Good morning, David.

David Adelman - Morgan Stanley

Were there any noteworthy changes first of all in the makeup of the holding company investment portfolio during the quarter?

James Tisch

No, nothing, nothing of any great significance.

David Adelman - Morgan Stanley

Okay, and then Jim from time to time in the last couple of years you’ve updated the market place on your sort of overall views about the economy and sort of the appetite internally for acquisitions. Could you just bring us up to date on your thinking there as we stay on today?

James Tisch

My view on the economy actually is the same that it’s been for the past two or three years. The decline that we had in ’08 and going into ‘09 came about, because of an over levered U.S. economy and as a result of the economy being over levered it is very difficult to get that bounce of the bottom that you would ordinarily expect from a recession.

So, we are now growing probably over the last quarter, the second quarter I think came in at 2.4% and many analysts are now forecasting that going forward in the second half of the year, we could have growth of less than that amount because of the fiscal drag coming about from state, government as well as the way the stimulus money starts to ebb as well.

So, I am generally in agreement. I think that the second half of the year, growth should probably be in the zero to 2% and I think going forward its going to be very difficult to get this economy cranking at a faster rate growth because of the continued high levels of debts.

So, when we factor that into our forecast for individual companies, I just don’t understand how the bottoms up analysis of earnings that gets you to this enormous growth in [S&P] earnings is actually going to come to fruition, and so when we think about acquisition, we think about it in the context of full growth [ph] economy as opposed to an economy that’s going to take off.

David Adelman - Morgan Stanley

Okay, thank you.

James Tisch

Thank you.

Operator

(Operator Instructions) Your next question comes from Josh Class [ph] with Manikay Partners.

Josh Class - Manikay Partners

Hi, Jim. I was wondering if you could update us to the extent, the CNA transaction with Berkshire expedites CNA’s ability to repay the preferred shares?

Jim Tisch

The Berkshire transaction significantly de-risks the CNA balance sheet by taking hopefully forever CNA’s fastest liabilities off the table, and I think that a number of CNA’s regulatory and rating constituencies understand that as well. We Loews, are hopeful that CNA will pay down the preferred.

It’s nice to receive the 10% dividend on that preferred, and it will be missed when the preferred is paid down, but remember once that preferred is paid down then depending upon a lot of factors, but CNA could be capable of paying a dividend to all its shareholders, and so Loews could receive cash flow from a CNA dividend on its common stock as opposed to dividend on its preferred stock.

So, I heard the CNA call, I heard people worrying that the repayment of Loews preferred had to be mutually agreed by Loews and CNA and I’ll just remind everyone that CNA has already paid off $250 million of that preferred by mutual agreement of the two companies.

Josh Class - Manikay Partners

Great. Thank you.

Operator

Thank you. At this time we have no further questions, so I’ll now turn the call back over to Darren Daugherty for any closing remarks.

Darren Daugherty

Thank you for joining us on the call today. A replay will be available on our website, www.loews.com, in approximately two hours. That concludes today’s call.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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