Frank Constantinople - Group MD and Head of IR
Paul Giordano - President and CEO
David Shea - EVP and CFO
Ed Hubbard - EVP and President and COO of XL Capital Assurance, Inc.
Gary Ransom - Fox-Pitt
Dana Halverstad - Goldman Sachs Fixed Income Research
Steve Winn - Bradford Wezyk
Darin Arita - Deutsche Bank Securities
Elaine Crowell - Banc of America
Adnan Elan - Adora Investments
Jonathan Hatcher - Morgan Circle Capital Partners
Ian Gutterman - Adage Capital
Martin Jacks - Rogers
Security Capital Assurance Ltd. (SCA) Q4 2007 Earnings Call March 14, 2008 8:30 AM ET
Good morning, ladies and gentlemen, and welcome to the Security Capital Assurance 2007 fourth quarter and full year Earnings Call. (Operator Instructions)
It is now my pleasure to introduce Mr. Frank Constantinople, Senior Managing Director and Head of Investor Relations for SCA. Mr. Constantinople, you may begin.
Thank you, Melissa. Good morning and welcome to Security Capital Assurance's fourth quarter 2007 earnings conference call.
I am Frank Constantinople, Group Managing Director and Head of Investor Relations at SCA. With me today are Paul Giordano, SCA's President and Chief Executive Officer; and David Shea, SCA's Chief Financial Officer. Also joining us for this call are Ed Hubbard, Executive Vice President and President of SCA subsidiary, XL Capital Assurance; Claude LeBlanc, Executive Vice President, Corporate Development and Strategy; and Drew Hoffman, XLCA Group Managing Director and Head of Portfolio Surveillance.
This call is also being broadcast online and can be accessed through the Investor Relations page on SCA's website, www.scafg.com. Also on SCA's website are our earnings press release, quarterly operating supplement and a brief slide presentation that summarizes SCA's 2007 fourth quarter results.
We will be updating the disclosure of our CDO and RMBS supplements. However, these supplements will be posted to the Investor Relations section of our website concurrent with the filing of our Form 10-K with the Securities and Exchange Commission.
At the conclusion of our prepared remarks, we'll then respond to questions. As you know, we ask that questions be submitted to us in advance for this morning's call, which should enable us to address as many topics as possible in the allotted time.
Before I turn the call over to Paul, I would like to remind everyone that certain matters that will be discussed here today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of factors could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements are sensitive to many factors, including those identified in our most recent report on Form 10-Q and other documents on file with the SEC that could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements speak only as of the date on which they are made, and we undertake no obligation publicly to revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
This presentation includes non-Generally Accepted Accounting Principle measures, such as adjusted gross premiums, operating and core income and adjusted book value, which, under SEC Regulation G, we are required to reconcile with GAAP. The reconciliations of these measures to GAAP financial measures are included in our earnings press release, which is available on our website.
I will now turn the call over to Paul.
Thank you, Frank. Good morning and welcome to our fourth quarter 2007 earnings call.
I will begin this morning by highlighting some of the most important developments that have affected our company over the last few months, and then describe where we are in examining our strategic options. I will then turn the call over to David Shea, our Chief Financial Officer, who will review our financial performance for the fourth quarter and full year 2007 together with some of the key financial metrics for our company.
Ed Hubbard, President and Chief Operating Officer of our primary insurance operations at XLCA, will conclude the management remarks portions of our call today by reviewing our insured portfolio and focusing on the exposures of greatest interest to many market participants.
As we all know, the latter half of 2007, and in particular, the fourth quarter was an eventful and difficult time for the global credit markets, financial institutions in general and the financial guarantee industry in particular. One of the main causes of the tremendous levels of stress on the financial system we have all witnessed over the past few months has been the rapid and extraordinary deterioration in the performance of securities backed by US home mortgages.
Unfortunately, Security Capital Assurance has not been immune from these forces, as evidenced by the results we posted in the fourth quarter of last year. All of us at SCA are disappointed by these results. As the CEO of SCA, I am accountable for our overall performance.
Right now, the causes of the problems in the U.S. residential mortgage market are well known. For credit underwriting by mortgage originators over the past few years falling home prices, tighter credit standards and slowing growth in the U.S. economy have all contributed to delinquency in foreclosure rates significantly in excess of historical experience for subprime borrowers in certain other segments of the mortgage market.
How all this will play out over time is not yet clear as predictions made by economists, analysts and market observers still vary significantly. It is also too early to measure the potential effects from lower interest rates and actions by the Federal Reserve bolster liquidity in the financial system. I have said, we've taken, what we regard to be a cautious approach towards the impact of home mortgage performance on the ABS CDO's and RMBS credits that we insure. Ed will describe our approach to establishing case reserves in greater detail a little bit later in the call.
Before describing the strategic options, we are currently exploring, let me briefly summarize where we find ourselves at the present time. In the fourth quarter, we recorded net case provisions of $688.7 million, in connection with the ABS CDO and HELOC lines of business. Total net unallocated and case reserves now stand at $92.9 million and $709.4 million respectively.
Over the past few months, our insurance and reinsurance operating subsidiaries have been downgraded from AAA to single A or single A minus by Fitch, Moody's and S&P. Although new business production measured by adjusted gross premiums was $155.6 million in the fourth quarter we stopped writing new business earlier this year due to market uncertainty and our lower ratings.
At December 31, 2007 we had total shareholders equity of $427.1 million and total common shareholders equity of $180.5 million. In addition to the case loss provisioning that occurred during the fourth quarter, the decline in shareholders equity was also lowered due to the additional $518.8 million of unrealized mark-to-market losses in respect of protection we provide in credit derivative form.
Cash flow from operations was $79.1 million in the fourth quarter. We have total paid losses in the fourth quarter of $7.5 million. We did not declare dividends on our Series A Preference Shares or on our common shares in the first quarter of 2008. With respect to regulatory solvency at year end, XLCA had regulatory capital of $233.8 million while XLFA’s regulatory capital totaled $829.6 million. The capital of both companies was in excess of statutory requirements at year end.
The principal strategic challenge we face today is the loss of our AAA ratings and the need to raise or generate large amounts of capital for rating agency purposes in order to restore our ratings to at least the AA level and ideally the AAA level. If we are successful this would allow us the ability to resume writing business. Last fall we began working out plans to address potential capital shortfalls after the rating agencies announced they were reviewing the capital adequacy of the financial guarantee industry as a whole. Goldman Sachs was retained to advise us in this process. We continued our work into December when we announced our plans to address our capital shortfall including using the existing or new reinsurance arrangements, restructuring certain of our insured obligations with our counter parties and raising additional debt or equity capital from external sources. One of the things we did to facilitate implementation of several elements of our plan was to retain a recognized global investment and risk management firm to assist us in evaluating our ABS CDO exposures.
Despite efforts to implement our plan we announced in late January that attracting third party capital was not practical under current market conditions, but efforts to generate capital for rating agency purposes from reinsurance and restructuring certain of our insured obligations continued since then.
In mid February the New York Insurance superintendent endorsed the possibility of restructuring financial guarantors in a way that would separate their public finance and perhaps certain other lines of business from their restructured finance portfolios.
Despite the complexity of restructuring or dividing a financial guarantor along the line suggested by the New York Insurance superintendent or in other ways we've given careful consideration to the potential merits of such an approach.
Rothschild was retained to provide us with specialized advice considering our options and we've maintained a close dialog with all of our principle regulators over the past few months including the New York Insurance department. Currently we are evaluating one or more of the following alternatives as elements of our strategic plan.
Generating capital internally by not writing new business for a time, as old business rolls off rating agency capital is created as we are not redeploying it. We are continuing to pursue commutations, restructurings and settlements, with regard to certain of our insured obligations. If this can be accomplished on satisfactory economic terms, such transactions can create capital that we otherwise would be required to hold against these exposures.
Examining the possibility of commuting, terminating or restructuring ceded reinsurance or other similar arrangements for our benefit while doing so can generate capital or add to our liquidity position.
Considering potential ways to restructure our business to make it more attractive to raise new capital, to support our public finance and potentially other lines of business not related to CDOs or residential mortgage assets.
Taking steps to preserve liquidity where feasible and matching our operating expense structure to our new strategy going forward as that becomes clear. We have abandoned communication with many of our bank CDO counterparties on an individual basis for sometime, and we are now in a process of organizing them into a group. This should facilitate our ability to work with them in connection with executing some of the alternatives that I just described.
Our goal is to emerge with the going-forward business on which we can acceptable returns on capital. Although some parts of our business, such as CDOs, are not likely to be resumed, we believe the demand for financial guarantee, insurance and reinsurance should return over time, as the global credit markets recover. In particular, we see opportunities BobInsurance to add value in the US public finance, global infrastructure and utility sectors. Despite the entry of Berkshire Hathway into our industry, (inaudible) entry generally remained high due to the need for AAA or at least AA ratings and a long period of time needed to generate acceptable returns on capital for start-up financial guarantors.
At this point, it is too early for us to say whether we will be successful in implementing some or all of the elements of the plan that I just outlined. As this is a complex process, the time it would take to implement the key elements of our plan is difficult to predict, although we wish to act as quickly as possible. The elements of our plan could change over time as well.
Separately, I would like to comment on a recent development that occurred in the first quarter of 2008 with respect to seven of our ABS CDOs that we have with one counterparty. Information came to light during the first quarter that let us to believe that this counterparty had breached its contractual obligations to us in a fundamental way, effectively, repudiating the contracts and giving us ground to terminate ABS CDOs in accordance with their terms. We terminated six of these ABS CDOs in February and the seventh in March. The counterparty has notified us that it disagrees with the effectiveness of these terminations. The case provisions established for these contracts as at year end 2007 were $427.4 million net of ceded reinsurance. This represents a significant portion of the total net case loss provisions taken during the quarter against the CDO of ABS portfolio. We intend to pursue our rights fully with respect to this matter.
With that, I will now turn the floor over to David.
Thank you, Paul. This morning I will start with a brief financial overview of our 2007 fourth quarter and annual results. Then I will spend some time reviewing our fourth quarter mark-to-market adjustment and loss reserve provisions, along with a more detailed review of our financial performance. I will wrap up with the discussion of certain financial fundamentals before handing the presentation over to Ed Hubbard.
First, a brief update on our 10-K filing. In the company's filing with the SEC on February 29, 2008 for an extension of the due date to file our 10-K, the company indicated that SCA's independent auditors were evaluating whether their opinion on SCA's financial statements would include a "going concern" explanatory paragraph. The company expects to file its Annual Report on Form 10-K on Monday, March 17, 2008.
SCA expects that the company's independent auditors' opinion will not contain a going concern explanatory paragraph. The company also expects that such opinion will be unqualified, but will include an explanatory paragraph highlighting the company's decision to cease writing new business at the present time.
Now, turning to summary of our fourth quarter and annual financial results for 2007. For the fourth quarter of 2007, SCA reported a net loss to common shareholders of $1.198 billion or $18.67 per share compared to net income of $35.8 million or $0.56 per share in the fourth quarter of 2006. For the full ended December 31, 2007 the company's net loss to common shareholders was $1.225 billion or $19.09 per share versus net income to common shareholders of $117.4 million for the full year 2006 and $2.18 per share.
The significant net loss in the fourth quarter was driven by our reported net mark-to-market loss on derivatives which totaled $1,163.9 billion including a net credit impairment of $645.1 million and additional net loss reserve charges of $37.2 million associated with our RMBS exposures.
As many of you know, management and financial analysts use operating income as a more representative measure of the financial guarantors' performance. Operating income is the non-GAAP measure which is defined at the end of this presentation as well as in our recent earnings press release.
For the fourth quarter of 2007, SCA posted an operating loss of $678.1 million or $10.57 per share compared to operating income of $37.1 million or $0.58 per share. And for the full year 2007, the operating loss was $530.3 million or $8.27 per share versus full year 2006 operating income of $141.9 million or $2.64 per share. The net charges taken in connection with the credit impairment charges within our CDO of ABS mark-to-market adjustment, and case loss reserves taken in our RMBS exposures during the fourth quarter of 2007, totaled $688 million and on per share basis this charge was $10.72.
I'll now review our fourth quarter mark-to-market adjustment. In regard to our Credit Default Swap portfolio, we view the guarantees we write in credit derivative form to be substantially the same as our guarantees written in traditional insurance form. Both are held to maturity and not traded. We are not required a post-collateral on our CDS contracts.
So we are required to fair value our CDS portfolio for financial reporting purposes. It is important to note that any unrealized losses associated with this fair value is not included in the calculation of SCA's net worth and capital ratios under the covenants of its credit facility, nor is it included in the calculation of any regulatory capital ratios for XLCA or XLFA.
The turmoil on the structured credit market we observed in the third quarter of 2007 continued to worsen in the fourth quarter. The market turbulence caused the valuation model that market may pursue light upon to become less dependable, and as a result, they have stepped away from their role as pricing information providers.
This, along with the deterioration in the ABS CDO portfolio, directly impacted our fourth quarter valuation process, requiring us to look at a much broader array of pricing information not previously considered. This new information included deterioration and rating downgrades of the ABS CDOs, an extensive ground up internal risk assessment of the ABS CDO portfolio, total evaluations of certain CDS policies, price discovery associated with our discussion with counterparties regarding potential commutation or restructuring of certain CDO contracts.
Our approach to determining our estimate of fair value of our CDS contracts at December 31, 2007 was based under valuation of all available market data points. These data points were considered along with management's judgment and include in our valuation model for each CDS asset class.
Given a limited market price information available in the fourth quarter, SCA feels that various methodologies used in our recent valuation process fully incorporate all indicative price evidence available to us and result in our best estimate of the fair value of our CDS contracts at December 31, 2007.
For the fourth quarter mark-to-market of our CDS portfolio, we utilize the income approach fair value model consistent with our historical practice. Majority of our deals are valued using the income approach methodology.
We believe the principle advantage of using our income pricing model is that it enables us to make a better estimate of the fair value we can receive in a transfer to a knowledgeable market participant. We assume such participant is capable of understanding the risks in the portfolio, has capital requirement similar to ours and will price the contracts reflecting a rate of return commensurate with the risk.
The income model calculates the fair value of our credit default swap portfolio by adjusting the present value of expected remaining future net cash flows under the contract to reflect a rate of return appropriate for the given transaction in the current market environment on the capital required by the rating agencies. Rate of return we assume would be required by market participants were increased to reflect the credit environment in the fourth quarter.
Another data point the company considered in assessing the fair value of it CDS exposures in our fourth quarter mark-to-market is the prices received from advanced discussions with certain counterparties about possible commutation or restructuring of CDS contracts. Paul referred to this commutation or restructuring as an element of our strategic plan.
Price discovery process resulted in about $692 million of accumulated unrealized loss or almost 47.1% of the total. Lastly, we also have several exposures where we use quoted indexes and broker quotes as the basis for fair value that totaled $60 million or 4.1% of the accumulated year-to-date unrealized loss.
SCA calculated a net mark-to-market loss of $1,163.9 million of the fourth quarter, which included a net $645 million of credit impairment associated with certain CDO of ABS. I will discuss this impairment in a moment.
For 2007, the accumulated balance of mark-to-market net loss totaled $1.469 billion. Subtracting the $645 million in credit impairment from the accumulated total loss of $1.469 billion gives a balance of $823 million. We consider this $823 million as a pure net mark-to-market charge that we would expect to accrete back to zero as the related deals amortize and approach maturity.
For 2007, within the CDS portfolio, CDO of ABS accounted for the most significant amount of mark-to-market loss and all the credit impairment charge, only accounting for 28% of the total CDS par exposure. This reflects the rapid deterioration in the RMBS collateral component that backed these types of CDO structures.
Turning to our loss provisioning for the quarter, as previously mentioned, reported case loss reserves that are embedded in our CDO of ABS net mark-to-market loss adjustment, totaled $645.01 million as referred as a case loss provision in our press release.
For the 13 ABS CDO transactions subject to the case loss reserving action, the net par outstanding at the end of the year was $8.6 billion or approximately 51% of SCA's insured high-grade CDO of ABS portfolio, which totaled $16.8 billion at yearend. Three of the 13 transactions account for about half of net loss reserve charge alone.
The case loss reserves for ABS CDO were based on highly detailed ground up modeling of expected cash flows for e-security. Accumulative results of our internal modeling were collaborated by cash flow modeling performed by highly regarded outside third-party using their own methods and assumptions. Ed will provide more details on this approach in a few moments.
The result of this modeling produced an estimate of the timing and amount of future claims and recoveries on each CDO. The case loss reserves recorded are based on the net present value of those future claims and recoveries. This founded at an internal investment rate of 5.1%.
It is important to note that the outside third-party also evaluated our portfolio, arrived at a very similar loss amount for the portfolio within 5% of our final estimate. In addition, we set aside a case loss reserve of $216.7 million gross or $37.2 million net for our direct RMBS exposure to HELOC and closed end second lien transactions that we've insured. The case loss reserve is primarily associated with 2006 and 2007 vintage RMBS collateral.
I'd also like to now briefly review the fourth quarter and full year 2007 production results. AGP, or adjusted gross premiums for the 12 months ended December 31, 2007 was $549.1 million, compared to $556.1 million in 2006 representing a decrease of 1% for the year. AGP in the primary insurance segment fell 7% to $478.6 million in 2007 from $514.1 million in 2006.
On the reinsurance segment, AGP increased 68% to $70.5 million in 2007 from $41.9 million in 2006. SCA's adjusted gross premiums for the fourth quarter of 2007 declined 21% to $155.6 million from $197.2 million in the fourth quarter of 2006. Strong production in public finance was offset by lower volumes, restructured finance and international segments.
Total premiums written were $91.9 million in the 4Q 2007, a decrease of $41.7 million or 31%, as compared to $133.6 million in 4Q 2006. The decrease is primarily due to the $39.4 million decrease in gross premiums written by the insurance segment, which is driven by the $34.9 million unfavorable variance in global infrastructure.
Upfront premium written in the insurance segment totaled 53% in 4Q 2007 versus 77%. Earned premiums rose 29% in the fourth quarter of 2007 to $57 million as our backlog of business increased during the year from the prior period. Refundings contributed $2.6 million to earned premiums during the quarter. The full year 2007 earned premiums were $215.7 million which was up 18% compared to $183.1 million in 2006.
Core net premiums, which exclude the impact of refundings and accelerations were $54.3 million for the fourth quarter of 2007 as compared to $42.5 million in the prior quarter a 28% increase. For 2007 core premiums were $201 million a 28% increase from the $155.6 million in 2006. Investment income in the fourth quarter of 2007 was $32.7 million, which was 32% higher when compared to the $24.7 million for the fourth quarter of 2006. The increase was primarily due to higher average invested assets to the operating cash which was generated during the year along with a higher investment yield in 2007 versus 2006.
In 2007 SG&A posted an investment return of portfolio of 4.93% net of fees as compared to 2006 when it yielded 4.65%. The twelve months ended December 31, 2007 investment income totaled $120.7 million up 55% from $77.7 million in 2006. Operating expenses decreased 4% in the quarter -- fourth quarter 2007 for $22.7 million versus $23.6 million in the fourth quarter of 2006. Operating expenses were up 25% for the full year and totaled $98.9 million in 2007 versus $79 million in 2006. The increase in expenses was associated with higher compensation related expenses as well as legal consulting and investment banking advisory fees to the development of our strategic plan. These were partially offset by our lower bonus accrual in the fourth quarter.
Lastly while we expect legal and advisory fees to increase during the 2008 year, we plan to offset this increase by tightly controlling operating expenses for the remainder of the year. We are in the process of examining our overall cost structure, headcount in relation to current business demands have already begun to significantly reduce all travel and entertainment and advertising expenses. While these decisions are never easy we believe it is necessary to take appropriate action in light of the current market conditions and to strengthen the company’s position as we navigate this difficult environment.
As our cost reduction plans are finalized we plan to update all of you accordingly. Adjusted book value or ABV is a non-GAAP financial measure defined as common shareholders equity plus the after tax value of deferred premiums, net of prepaid insurance premiums and deferred acquisition costs plus the after tax net present value of future installment premiums and [of course] discounted at 7%. ABV is used by equity analysts and investors to estimate the embedded value of the business that has being created by the company for the benefit of its common shareholders.
The company’s ABV was $1.501 billion or $23.39 per share as of December 31, 2007 versus $2.448 billion or $38.17 per share as of December 31, 2006. The decline in ABV was due to mark-to-market charges associated with the credit derivative portfolio that we discussed earlier along with the case loss provisions that we established against CDO pf ABS, HELOC and closed end second lien portfolios.
Let us spend a few minutes reviewing SCA’s financial fundamentals. This will include the potential impact of rating downgrades and SCA liquidity. Given the recent rating agency downgrade of SCA, we previously discussed the potential impact these actions may have on our insured portfolio and premiums earned. For XLCA as of year end 2007 it's all eligible policies are canceled. This would result in the loss of $35.6 million in future installment premiums for the life of these contracts. For 2008 reduced premiums earned by estimated $3.3 million. For XLFA, the downgrades could potentially trigger a prospective increase in ceding commissions or primaries right to call back the ceded business. The ceding commissions are raised this would have an impact of approximately less than $10 million annually on XLFA's earned premiums. If the primaries choose to continue the business, they'll require XLFA to return about $138.7 million in premium net of ceding commissions.
In terms of liquidity and the ability of SCA (inaudible) operating subsidiaries to meet obligations going forward in 2008, we believe we are well positioned. The discussions eventually [would recover] holding company cash and sources of liquidity.
I'll start with the profile of our holding company SCA Limited which by design is dependent upon periodic dividends and distribution from its insurance and reinsurance operating companies to fund ongoing operations. As of the year end the holding company's current cash and cash equivalent position is $23.5 million as part of our planning process we fund the rolling four quarters of operating requirements in advance.
Our primary sources of liquidity are the operating cash flow generated by the back book of business we've established and the investment portfolio cash flow from investment returns. As part of the unique aspect of our business model, and although we have ceased writing new business, we expect to receive approximately $142 million in scheduled installment premium payments in 2008. These premiums are associated with the back book of installment business we've written in prior periods.
In fourth quarter SCA Limited has $79.1 million in net operating cash flow on a consolidated basis. This was down from a prior quarter of $133.8 million primarily through the closing of several large upfront premium transactions in the period for 2006. For the year SCA had $285.5 million in net operating cash flow, and this is lower when compared to $393 million with the decrease driven by the aforementioned upfront premiums received in the fourth quarter of 2006.
The holding company operating subsidiaries have access to an unutilized $250 million revolver as part of its credit facility established at the time of the initial pubic offering. We have no debt at the holding company and our $250 million hybrid preferred series A issue is non-mandatory and non-cumulative instrument. Board of Directors of SGA Limited has announced that they will not declare dividend on its common shares and the hybrid preferred series A securities in order to strengthen our capital position in the first quarter of 2008 resulting in approximately cash savings of $9.9 million. The Board will revalue its decision on a periodic basis.
In regard to dividend and distribution capacity, XLFA Limited hasn't reviewed regulatory guidelines capacity in 2008 to make $122 million in distributions and $13 million in dividend at SCA Limited. XLCA, our primary financial guarantee company and only pay dividends from retained surplus, and as such, XLCA currently cannot pay dividend due to its cumulative loss position. The situation from XLCA is not expected to change over the near term.
I will spend a minute on investment portfolio. Investments, cash and cash equivalents instruments currently totaled $2.7 billion. These investments consist of high quality fixed income instruments for the weighted average rating of AA+. Our subprime RMBS investments were $12.3 million and are AAA, while our all day MBS investments approximate $30 million and are primarily AAA rated. The management of SCA investment portfolio was outsourced by experienced outside advisers. No bonds in the investment portfolio are wrapped by any other financial guarantor and as a matter of policy either XLFA or XLCA own any of the bonds that are wrapped by XLCA.
In closing, assessing our financial condition liquidity, we believe SCA is in good position to pursue our strategic plan. We have made appropriate assumptions around our case reserve actions and we believe we would be able to manage our liquidity, consumer obligations and maintain operations as outlined in our strategic review.
I will now turn the call over to Ed Hubbard.
Thanks, David. I intend to describe more fully our exposure to residential mortgage-backed securities and CDOs, but I would first like to describe the context provided by our overall insurance portfolio which totals $165 billion at year end 2007. The majority of which is of sound credit quality. In areas where we do have the most significant credit concerns, are focused on our $16.8 billion of net par exposure to ABS CDOs and the $3.2 billion of net par exposure to home equity line of credit or HELOC securities.
As mentioned previously, we are reporting case loss reserves for our ABS CDOs of $838.6 million gross of reinsurance. Net of reinsurance is amounted $151.5 million. This charge relates to 13 ABS CDO transactions with net par outstanding at year end of $8.2 billion or about 49% of our insured high grade ABS CDO portfolio. This $8.2 billion in par exposure has been added to our [loss list] to credit exposure. As Paul noted earlier, SCA has issued notices terminating seven of the Credit Default Swaps pertaining to ABS CDOs with an associated net case reserve amount of $427 million.
The fourth quarter reserve action we are recording for ABS CDOs and certain RMBS transactions is the result of a comprehensive review undertaken by management over the past quarter. As Paul has noted, it is obvious that credit markets have experienced a rapid and unprecedented deteriorations since the third quarter. Evidence of the widespread credit downturn could be found in the extensive rating agency downgrades of RMBS and CDO securities. Progressively weaker mortgage collateral performance reflected in remittance reports over the past few months and declines in various other market indicators such as the ABS.
In summary the factors changed materially and significantly since the third quarter and we have done our best to establish case reserves which reflect the best information available to us at this time.
I would now like to give you some backgrounds on the credit review and performance. Let's start first with our $16.8 billion of ABS CDOs which comprised the 25 separate ABS CDOs we insured. We will disclose further information on our ABS CDOs on our company's website. We analyzed each of these 25 ABS CDOs using a model we developed, which forecasts expected cash flow from each security on lease by the CDOs. The expected cash flows from each securities or piece of collateral are then aggregated and run through a separate cash flow model developed for each CDO based on the unique structural features as provided for in our underlying documentation. In this manner, we modeled year-by-year cash flow for each CDO after its legal final maturity and estimated collected cash shortfalls on the CDO charges guaranteed by SCA. We then discounted the estimated interest in principal shortfalls using a discount rate of 5.1% which corresponds to the book yield on our investment portfolio.
With respect to our ABS CDO case reserves, it is important to note that the losses we are estimating are expected to occur over a long-time horizon. In fact our modeling indicates that weighted average life associated with our estimated claims payment is 33 years. Another way to describe this is that, 89% of the estimated losses occur between years 30 and 40. Because (inaudible) anticipated payment claims will occur for decades. We do not expect such claims payments to post a significant near-term liquidity issue absent significant adverse development.
Separate and in part from our modeling work has its been mentioned, we engaged a recognized global investment and risk management firm to value each of our ABS CDOs using their own methods and assumptions. The aggregate present value calculated by the third party also used in a LIBOR based discovery within 5% of the comparable value calculated by our own internal model and therefore served as a [corroboration] of our results. Further this third party analysis confirms our view that potential CDO losses are indeed [long dated] in nature. There are two primary reasons like potential CDO losses or long dated. First our modeling indicates that even under stress scenarios the high grade ABS CDOs in our portfolio are fairly robust in their ability to cover interest payments on the senior most tranches. This is because the CDOs are structured to apply principal collections from the collateral [vaults] to pay interest obligations under senior tranches combined with various rules like to pay cash sequentially to senior tranches and set up cash to junior tranches once all the collateral evasion triggers are tripped.
Second to consult the way our ABS CDOs guarantees are structured we are only responsible for scheduled interest and ultimate principal payments. This means that we are committed to cover principal shortfalls only at legal final maturity which is typically 35 years to 45 years from deal inception.
Our obligation to pay current interest and ultimate principal is, further supported by the [right way] gains with respect to a CDO event as default. Such rates give us the ability to block our liquidation as the CDO's collateral without our consent. We can best force a CDO to run to its legal final maturity, so both the structure of the CDO combined with the rates we gain allow us to postpone the day when we have to cover a potential principal shortfall.
First let me spend just a moment on the structure of our Credit Default Swap. As I have just noted all of our Credit Default Swap for ABS CDOs provide for the timely payment of interest and ultimate payment of principal. However for other types of CDOs typically synthetic CDOs with reference either a basket of corporate credit or commercial mortgage backed securities. We have written Credit Default Swap, which will cover individual collateral losses within a poor collateral once the deal deductible amount has been [exhausted]. At year end 2007, we had guaranteed $10.7 billion of such synthetic CDOs. As we intended for none of the Credit Default Swap which we had written exposed us to mandatory collateral posting requirements.
Let me now describe our modeling process in a bit more detail. As I mentioned our model analyzes each and every security owned by the ADS CDOs we guarantee. We also analyze the security sell by inner CDOs to ensure that we have captured the appropriate level of detail.
Our model consists of several key components. First we made use of the third party database Loan Performance Systems or LTS to help us drill down to the level of individual mortgage loans within each residential mortgage backed security. Using LTS, helped us to properly identify the characteristics of each mortgage loan, such as the combined LTV ratio, the type of mortgage product, lien status, credit score of the borrower and so on. By using LTS we are able to build a cumulative loss forecast for the collateral flow supporting each individual RMBS.
Next, each security level cumulative loss forecast was then used as an input to Intex which is widely used tool for modeling asset backed securities, in fact allowed us to model expected losses for each mortgage security owned by ABS CDOs. Finally we built a proprietary cash flow model for each of our ABS CDOs which factored in the structure of the CDO and specifically took into account the impact of over collateralization triggers and have entered the fall provisions as specified in the indenture for each ABS CDO.
Before I go further I may help to describe the layers of securities within an ABS CDO. for which we have sold credit protection the outer CDO. A typical outer CDO in turn, owns approximately 185 different securities on average. We call these 185 securities, 1st layer securities and out of these 185 you will typically see about 150 residential mortgage backed securities and 35 securities which are tranches of other CDOs, what we call inner CDOs. The modeling process we use for ABS CDOs analyze each 1st layer security and within the inner CDOs each 2nd layer security. Thus, for each of the ABS CDOs we guarantee our model analyzed approximately 5,000 individual securities.
We kept our model drilled down to the individual loan level to build loss forecasts. We took into account the significant differences, which exists from one RMBS pool to another. We think it is critical to recognize that not all 2006 subprime RMBS deal for example, will perform the same. Instead, performance will be the function of both the originator and the precise collateral characteristics of the mortgage loan pool. We believe taking such a detailed round up data driven approach is the best way to estimate the intrinsic value of ABS CDOs and address the shortcomings of some third party loss estimates based on broad brush assumptions.
CDO expense for the dispersion of loss estimates which results from taking a detailed round up approach. Our model forecasted individual subprime cumulative losses ranging from 6% to as high as 25% in the case of certain subprime securities. Another benefit of such a detailed approach is that it allows you to more precisely identify the vintage of individual collateral supporting (inaudible) and CDO. Within our ABS CDO portfolio for example, 52% of the subprime mortgage loan collateral supporting RMBS was originated prior to June 30, 2006. This is important because residential mortgage collateral originated prior to the second half of 2006, it is performing significantly better than later vintage collateral.
We were careful to use what we regard is a proven set of assumptions in modeling the cash flow from inner CDOs. For example, we took care to model event of default associated with inner CDOs which could cost interest payments to be shut off. On average our model forecast at inner CDO buckets stopped paying 20% of interest after only one month and 40% of interest after 12 months.
In addition, we took a cost reoccurrence with respect to the third layer CDO where we assumed an immediate loss of 75%. I would like to highlight that our ABS CDO case reserve is based on recent data that recognized this is a difficult task in the current environment. We are comforted by the fact that an independent assessment by a recognized investment and risk management firm arrived at very similar loss estimates for the portfolio.
Wirth respect to the rest of our CDO, portfolio which includes $14.4 billion of CLOs, we have not seen material deterioration in the performance of the underlying collateral, and part of this SCA also writes $4.5 billion of commercial real estate CDO's comprised of [ADLs]. The climb up consists entirely of AAA rated CMBS securities, and we have not seen any significant deterioration to-date in the securities.
The $1.8 billion of our CDO [squared] portfolio also continued to perform well. CLO's make up the majority of the collateral at 57% on average. The deals had very little 2006 and 2007 our RMBS collateral accounting for less than 2% in any CDO and the average subordination for a CDO squared portfolio is 31.6%.
I'd now like to provide an overview of our residential mortgage-backed securities portfolio. At year end 2007, our RMBS portfolio totaled $9.6 billion of net par outstanding. We will provide updated detail disclosures of our RMBS portfolio on our company’s website. The $215.7 million of gross case loss reserve mentioned earlier is associated with six transactions out of a total of 15 HELOC and closed-end second lien transactions we have insured. Five of these transactions are prime HELOCs and one is the transaction backed by Alt-A closed-end second lien collateral. Unlike estimated losses for ABS CDOs which are significantly back ended we anticipate that the majority of eight claims for HELOC and one closed-end second lien deal will occur over the next two to three years.
XLCA has paid claims on HELOCs starting the November 2007 with total claims paid through March 13, 2008 of $63 million. We estimate that total paid claims for RMBS for 2008 could approach approximately $200 million. However; this amount if it materializes would net down to approximately $50 million after reinsurance. Of the five HELOC to which have established case reserves, two are in rapid amortization and the remaining three are all expected to be in rapid amortization within the next few months. In rapid amortization all cash collections are used to pay down the senior certificates and new drawn by borrowers against their HELOC accounts must be funded by the servicer rather than from the deal itself.
As we discussed during our third quarter earnings call we highlight the potential need to take case reserves against the HELOC portfolio due to emerging delinquencies and charge offs. At that time we indicated that our HELOC deals would withstand cumulative collateral co-losses of between 10% and 14% before SCA would be exposed in that losses, meaning take claims for which we do not expect reimbursement. While we estimate that the average breakeven cumulative block threshold for our recent business HELOCs has increased to about 17%. We've also continued to see rapid deterioration within our HELOC portfolio. Based on our modeling of the five HELOCs, we know estimate that alternate net cumulative losses could reach an average of 22.5% of original principal balance. The average inception to-date, cumulative loss level for these five deals is 4.3% of the original principal balance. The 60 plus day delinquency is at 9.5% of the outstanding balance at year end.
Besides from SCA's HELOC exposure, we are taking a gross case reserve of $10 million in connection with one off day closed and secondly in transaction with net par outstanding of $255 million. This deal has exhibited very high delinquencies out of the box. We may recover a significant amount of loan put backs to the sponsor of its transaction. However because of the degree of collateral stress that we observed, we believe the case reserve is warranted at this time. Most of our remaining RMBS portfolio attached in the single edge AAA range and is performing satisfactorily. Based upon review of this portfolio and the remodeling we had performed, we are not establishing a case reserve for the remaining RMBS credit at this time.
Let me spend just a moment on our RMBS cash flow modeling. The model's key assumptions are default rate and prepayment rates and for the HELOC, also at the rate at which new [tranches] on the HELOCs are made. Our model assumes that default rates remain at or above the current levels for eighteen months, at which point we would expect performance to stabilize at a lower, but still distressed rate. To give you a sense for this, we have assumed peak default rates for CDRs -- for HELOCs ranging from 11% to 22% with an average peak default rate of about 18%.
All of the assumptions were incorporated in our modeling were based on recent performance data and were cooperated by a consultant. We are in the midst of reviewing the collateral supporting our HELOCs exposure for breaches of our representation made to us by the origination and services. Although as a result of this review, we believe we may be successful on putting back a significant number of loans. We have not incorporated any estimate at this time for such recoveries in our case reserve actions for the HELOC. The deterioration of our HELOC exposure and the associated case reserve reflects the trends we highlighted during our third quarter earnings call namely, HELOC originated in 2006 and 2007 separate from the same quarter underwriting that has broadly affected the subprime RMBS sector.
In particular we've observed very poor collateral performance associated with high combined [LCD] ratios, low documentation and unprecedented instances of borrower income misrepresentation. Finally, I would like to note that as of year end 2007, we had guaranteed approximately $9 billion of variable rate demand obligations or VRDOs and another $17 billion of auction refunds. Both VRDOs and auction refunds have experienced stress under current market conditions with the result of the efficient funding costs for their issuers has increased significantly.
We've been approached by a number of issuers seeking to restructure such obligations and we're working with them constructively to development appropriate solutions for their funding requirements.
That concludes my remarks and let me now turn it over to the operator for Q&A.
(Operator Instructions). I will now turn the call over to Frank Constantinople SCAs Head of Investor Relations.
Thank you Melissa. In order to run the calls efficiently and productively as possible, as indicated in my opening remarks, at this point we'll now respond to questions that were submitted to our website over the past week. We've organized these questions by broad subject areas such as strategy, insured portfolio, quality, liquidity etcetera. We've received the great deal of questions, some of which were in our answered in our prepared remarks and some of that were duplicative. In that case, we chose the most representative question that was post. We will provide attribution where permission has been granted for us to do. We've also received some questions more appropriate for XL Capital to answer and we are not in a position to comment on disclosures and XL's 10-K.
Lastly, we received the number of questions surrounding the CDS terminations mentioned in yesterday's earnings press release. Our lawyers have advised us not to make any further comments with respect to the terminations at this time, beyond what we have said in our press release. Other than to say, we consider the terminations effective and intend to enforce them vigorously. So let's begin.
First question for Paul and it's about strategy. It came in form Gary Ransom at Fox-Pitt.
Gary Ransom - Fox-Pitt
What progress has been made to-date on commutation, restructuring or settlement of your obligations as described in your strategic plan? Are there any divisions of the company into pars that might make sense to you?
Thank you, Frank. Our plan is complex and has a number of interdependent parts. I think we have made progress in terms of identifying what we would have to do to execute the elements of our plan and advancing certain parts of it. We've had a sense of discussions with the number of our bank CDO counterparties individually about commutation, restructuring or settlement. And we are in the process of organizing them into a group. The extensive analysis we have conducted on our ABS CDO book puts us in a good position to have discussions with our counterparties.
Based on the feedback we have received thus far, they are interested in pursuing discussion with us about what may make the most sense for us and then to do. We have also been reviewing ways to commute or restructure some of our inwards and outwards reinsurance arrangements, in some cases discussions are quite advanced. With our legal and financial advisors, we have also looked at ways to restructure our business that could make it more attractive to new capital providers especially around our U.S. public finance and international books of business.
We have a good idea of the kinds of things that are more likely to be executable as compared to other approaches. We have also maintained close contact with the investors or with investors who have a strong interest in the financial guarantee space. Particularly, in connection with the targeted type of restructuring I just mentioned. So a great deal has been done but we are still working our way through the process to see what maybe possible to achieve and I think it is still too early for us to be able to answer that question.
Okay. Thanks, Paul. There is a question that’s been submitted by several parties, regarding the XL relationship. Can you comment on what the dialogue has been with XL Capital?
Sure. We could tell you it would be a dialogue with XL Capital about our strategic plans. And I would characterize the dialogue we have been having as constructive. Also, XL is planning to fill the two vacancies on our Board created when Brian O'Hara and Alan Senter, XL's appointees to our Board, pursuant to their rights under the transition agreement we have with them, resigned late last year. And we have been speaking with XL about that as well.
Okay. Thanks Paul.
Dana Halverstad - Goldman Sachs Fixed Income Research
Next question is for David, and it is also concerning XL. Regarding the reinsurance recoverable, $187.1 million due from XL Capital subsidiaries and the portion of the $179.5 million recoverable from XL and other reinsurers, did the XL portions relate to reinsurance under the excess of loss reinsurance agreement between XLI and XLFA?
Yeah, Frank, SCA has reinsurance recoverables of $323.8 million from XLI and $52.4 million from XLRA.
Okay. Thank you, David. Moving to questions concerning, run-off which was another subject that we heard about. We received several submissions and this question is also for David, approximately how much capital can you free up by not writing any new business over a given timeframe six to 12 months?
If we assume no change in the credit profile of our portfolio over a 12 month period we would expect the average in rating agency required capital run-off to be in the range of $80 million to $120 million per quarter.
Okay and a follow up question for that, David, how much revenue can you generate from the run-off of your existing book? What proportion of your revenues, generally come from your current book of business versus your previous?
There are operating supplements. Scheduled earned premiums for 2008 are approximately $207 million, investment income would also contribute to revenues and I believe actually that contributed a $112 million of cash alone. Our investment assets were $2.7 billion as of the year end and our investment yield was 4.93% after fees.
Okay. And a question for Paul on run-off, we received several submissions on this. Is the company in run-off, could you comment on that?
No, we are not in run-off despite our having stopped writing new business earlier this quarter. We decided to stop writing new business due general market uncertainty and uncertainty around our ratings. Since being downgraded to single A or A minus by the rating agencies we've not been able to write business anyway. Where we are today is that we're focused on the elements of our plan to increase capital, raise our ratings and resume writing business in public finance and other business lines. At present our plan is not to put our entire business into run-off.
Okay. Thank you, Paul.
Gary Ransom - Fox-Pitt
Moving over to reinsurance, here is another question for you Paul. It was again submitted by Gary Ransom. How has the company's ratings affected your reinsurance business particularly with FSA? Do they have the right to commute at this point?
XLFA has sufficient liquidity to manage potential call backs. In all third party reinsurance agreements including those with FSA, which permeated on a cut-off basis we would have to return U.S. statutory unearned premium, net of ceding commissions of approximately $139 million as of December 31, 2007. In addition, the primary insurer, ceding company may also have the option to increase the ceding commission to a proprietary level in line with the rating of XLFA after its downgrade and any such increases will reduce cash flow from operations. To date no primary insurers have exercised their rights to terminate our reinsurance agreements with them.
Steve Winn - Bradford Wezyk
Okay. And a question from [Steve Winn at Bradford Wezyk]. On your current rating -- at your current levels could you write reinsurance business?
We believe it would be very difficult to write reinsurance business as a single A rated company.
Okay. Moving over to production I have a question for Ed. This was submitted by several parties. When during the quarter did your writings generally stop?
Sure. Paul commented on our business production for the fourth quarter and XLCA has pretty much maintained its pace with business productions through mid December and at that point business actually began to diminish significantly. As we've indicated XLCA substantially altered new business production in the first quarter of this year. With respect to XLFA it also substantially ceased writing business in the fourth quarter of 2007.
Thank you, Ed.
Darin Arita - Deutsche Bank Securities
Turning to liquidity, for David. Under what circumstances would dividend payments out of XLFA be limited and a follow on question from Darren, whether there were restrictions preventing XLCA and XLFA from up-streaming cash to the holding company?
I addressed some of those points in my remarks but XLFA is prohibited from declaring or paying any dividends during this financial year. If its in (inaudible) its minimum solvency margin or minimum equity ratio or a declaration or payment of such dividends would cause it to fail from such margin ratio. XLFA is also prohibited without the approval of the [Brigader Regulatory] from reducing by 15% or more of its total statutory capital as setup in its previous year's financial statements, additional details on this is going to be available in our 10-K filing. And then in addition the Brigader Regulatory can impose restrictions under certain circumstances set forth under the law. Any domiciled insurer may not declare or distribute any dividend except that earned surplus. Currently XLCA as I mentioned has a negative earned surplus therefore they are unable to declare or distribute dividends.
Okay, thank you David.
Elaine Crowell - Banc of America
Question for Paul, as we understand that, this came in from [Elaine Crowell] at Banc of America, insolvency will be deemed, a case of default under most CDS which gives the holders of the swaps the right to terminate the agreement and request payment based on the present market value of this loss at the time of termination. What is the definition of insolvency under that scenario? Is it based on statutory financial statements?
XLCA is the party involved in our CDS contracts and had over $200 million of statutory capital at year end 2007. As I understand that the word insolvency itself is not generally defined as a term in standard use of CDS documentation. The events of default set forth in the user contracts are mixed. Some focused on regulatory insolvency receivership and/or similar proceedings. Other is the contract set for the broader definition of insolvency but also includes regulatory actions.
Elaine Crowell - Banc of America
Okay, thank you Paul. And a follow-up question. How will the present market value of the swaps be calculated at the time of termination?
Again as I understand it, a calculation is made to determine how much it would cost for a party to enter into a transaction. I think commercial terms like those in the terminated transactions with an independent third party. Specific mechanism and timing for determining the amount of the termination payment is detailed in the swap documentation itself, most importantly quotations from several market makers are generally used in determining the termination payment.
Okay, thank you. Turning to expenses, David we received a number of questions regarding expenses, can you give us an idea of what kind of operating expenses you expect for the operating company going forward?
Yeah, we covered a little bit of this in my prepared remarks. But we are in the process of examining our overall cost structure and to the extent necessary the company will align the headcount expenses in relation to current business demand in our future plans.
Thank you, David. Okay. Turning to the portfolio question for Ed, a very timely subject. Do you anticipate any losses related to Jefferson County? Can you talk a little bit about that situation and how you anticipated getting results? That's been coming in from a couple of parts of the market as well.
Okay. So the short answer is no. We do not anticipate any credit losses from our exposure to Jefferson County and by way of background in year-end 2007 our net par exposure to Jefferson County was $811 million. As the recent news reports have indicated the County's finances has been really strange by a combination of collateral requirements as those were (inaudible) swaps as well as higher interest costs and liquidity strains associated with the Johansson auction incurred when we did that. What's happening now is we are participating in discussions with both County officials and the County's bank lenders and we believe that all parties are working constructably to improve the County's debt exposure.
Standard and Poor's reported that the County had available cash about $250 million on March 3rd, and I would note that the County is obligated under the terms of it's relevant bond indentures, to raise water and sever rates in an amount to sufficiently cover debtor obligations. We believe it's in the best interest to both the County and its bank lenders to arrive at a satisfactory resolution to its current situation. So, we'll continue our active participation in ongoing discussions and we will watch the situation closely.
Okay. Thanks, Ed
Adnan Elan - Adora Investments
And this might be worth repeating, question from [Adnan Elan] (inaudible) from Adora Investments. I know you have mentioned this in your comments but what portion of the case reserves do you expect to pay out this and next year?
Okay. Also we did note, we see the potential to pay claims in 2008 of approximately $200 million. That amount is gross of reinsurance and also gross of ultimate recoveries. After factoring in reinsurance the $200 million in potential claims payments should net down to about $50 million.
Adnan Elan - Adora Investments
Okay, thank you. And then a follow-up from Adnan, what are the vintages for the 13 high-graded multi sector CDO of ABS transactions, five HELOCs, and one closed-end second transaction that you booked for $698.2 million of cash reserves on?
Okay. Well broadly speaking, the vintages are spread across several years but there was concentration in 2007. As it turns out of the 13 ABS CDOs against, which we took cater service, eight were from the 2007 vintage, with the major from 2006 and before. For the HELOC case reserves one HELOC was originated in December 2005, three HELOCs were originated in 2006 and one in 2007. The one closed in second lien deal, for which we have taken a case reserve closed-end in 2007.
Okay. Thank you, Ed
Darin Arita - Deutsche Bank Securities
And moving over to finance, David, there is a question from Darren Arita what caused the delay of reporting the fourth quarter financial results?
Well, the market turbulence seen in the fourth quarter of 2007 was really unprecedented. And prompted the company to undertake a very cautious assessment of our insurance portfolio, and this is reflected in our financial results. We spent a significant amount of time reanalyzing the CDO of ABS portfolio, the RMBS exposures, in order to come up what we consider to be the cautious assessment of our insured portfolio quality. And SCA also engaged a highly regarded third party to independently evaluate our portfolio, and also given the magnitude of the case loss provisions that we have taken and the complexities associated with our mark-to-market, our independent auditor also will have a very thorough look at the approach we are following.
Thanks David. There is also another question for you from Jonathan Hatcher from Morgan Circle Capital Partners.
Jonathan Hatcher - Morgan Circle Capital Partners
What is the status and plan for the Twin Reefs security?
Okay on February 11th of this year XLFA exercised the [put] option on the Twin Reefs facility for the first time since it’s inception to issue $200 million of non-cumulative preference Series B shares. The purpose of this action was to enhance and preserve the liquidity and regulatory capital of XLFA. The newly issued preference Series B shares were paid dividends of month LIBOR plus 1% per annum calculated on an actual 360 day basis for any dividend period or, on or prior to December 9, 2009. Thereafter the dividend will step up to one month LIBOR plus 2% per annum charge.
Okay thank you. Ed here is a question for you. The $9.5 million charge related to the third party reinsurance business that was announced yesterday, was that previously announced on February 29th? In other words was it in included in any of the pre-announced charges or it rather is an entirely new…?
Frank the charge stems from to related to international transportation project financings which have been reinsured by XLFA. The project sought benefits from government financial support for 95% of the transaction. So the case reserve we have posted of $9.5 million represents a loss on the non-government supported with usual 5% rate.
Okay. David this is a question regarding the actual mark-to-market which and this question was submitted by a couple of different parties was different from what was pre-announced. We had a $1.5 billion charge announced I think it was February 29th and people are asking why was the actual mark lower? And the specific question 651.5 plus the 519 gives you a result of close to $1.2 billion, what was it that changed?
Yeah the $1.5 billion was referred to in our 12b-25 filing. The $1.5 billion was a gross charge calculated on the basis of gross case loss provisions plus the mark-to-market charge.
Thank you. And a follow up question. We are moving over to the CDS contracts. It is again for David. It is coming from a couple of parties. If you are successful in terminating the 7 CDS contracts do you get to reverse the related $427 million provision for case basis reserves and or the $204 million net unrealized loss?
Well the short answer is yes. The $427 million was included in the $651.5 million total net case provision that we highlighted.
Ian Gutterman - Adage Capital
And just a follow up question, David. Please clarify whether the $427 million case reserve related to the 7 terminated contracts is a gross or a net number? That is from Ian Gutterman from Adage Capital.
Yeah, the $427 million is a net result.
Ian Gutterman - Adage Capital
Okay. Thank you.
Okay and now for our final question for David. How much larger if at all were the impairment on the 7 Credit Default Swap contracts be if the counter party prevails in the dispute?
Well again the short answer is no. The net case provisions reflect the reserves associated with these 7 CDS transactions as of year end. The termination of these contracts was a subsequent event that occurred during the first quarter of 2008.
Okay. Thank you. Ed do you…?
Yeah. Frank. I have two additional questions that came in. One is from [Martin Jacks from Rogers].
Martin Jacks - Rogers
And the question is the claims that we've paid so far how could you reimburse or recovered?
We went through the numbers in terms of what we could obtain by LIBOR insurance recoveries. In addition to that we believe that we can obtain recoveries overtime from the deals themselves and a conservative estimate would be the cash claims that we expect to pay over the course of this year. We may realize claims or perhaps realize reimbursements to perhaps 30% of that amount overtime.
The second I have is a follow-up from Ian Gutterman.
Ian Gutterman - Adage Capital
And the question is, with respect to the estimated claims payment or cash payments on our CDO exposure do those amounts include any accelerated payments that maybe acquired due to [event] default language or any change in SCA's rating for solvency?
The answer is those amounts do not reflect those events.
Ian Gutterman - Adage Capital
And if not how could these payments change based on the SCA's credit rating or solvency?
I think we have covered this. Basically the payments on our CDO, CDS contracts are not impacted by SCA's credit ratings. The payments instead are based on the amount of interest and principal shortfall on the reference CDOs. And with respect to the question of our solvency, Paul has addressed the solvency issue in the other question we have received.
Okay. Thank you. Melissa, well, we take it back to you.
Thank you, this concludes the question-and-answer portion of the call. I will now hand the call back over to Paul Giordano for closing remarks.
Thank you. In closing I just wanted to make a few remarks today. Our industry undoubtedly needs to learn the lessons from this severe downturn in the credit markets. In addition to refocusing on public finance, international and other lines of business outside of structured finance I think you will see financial guarantors look even further beyond the underlying ratings of the transactions they ensure. Perform greater stress testing of both the individual transaction and portfolio levels and focus increasingly on economic returns rather than returns on rating agency capital. In my view the industry also needs a certain critical mass of financial guarantee insurers and reinsurers, in order to function efficiently and avoid fixed income investors and others having exposures that are too concentrated in a small number of bond insurers.
Finally I would like to conclude it by thanking our employees for their tireless efforts over the past few months and their professionalism. As we've worked through this difficult and extraordinary time for our company. Thank you all for listening today.
Thank you. This concludes today's SCA conference call and webcast.
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