RAM Holdings Ltd. Q1 2008 Earnings Call Transcript

RAM Holdings Ltd. (RAMR)

Q1 2008 Earnings Call

May 20, 2008 2:00 pm ET

Executives

Vernon M. Endo - President, and Chief Executive Officer

Edward U. Gilpin - Chief Financial Officer

David K. Steel - Chief Risk Manager

Victoria W. Guest - General Counsel

Analysts

Gary Ransom - Fox-Pitt, Kelton

Joseph DeMarino - Piper Jaffray

Allan Seymour - Columbia Management

Rick Sherman - Oppenheimer & Co.

David [Hepperman] - GSC

Orin McCluskey - Equity Value Venture

Presentation

Operator

Good day everyone. At this time I would like to welcome everyone to the RAM Holdings Limited First Quarter 2008 Results Conference Call. (Operator Instructions) With us today from the company is the President and Chief Executive Officer Mr. Vernon Endo; Chief Financial Officer Mr. Edward Gilpin; Chief Risk Manager Mr. David Steel; and General Counsel Miss Victoria Guest.

At this time I would like to turn the call over to Victoria Guest.

Victoria Guest

Good afternoon. Thank you for joining the first quarter 2008 earnings call of RAM Holdings Limited. I am Victoria Guest, General Counsel, and Secretary of the company.

Our press release regarding first quarter 2008 results, our first quarter 2008 operating supplement, and information regarding our mortgage and CDO exposures were released yesterday and are available on the investor information section of our website at ramre.com.

Yesterday we also filed our quarterly report on Form 10-Q for the quarter ended March 31, 2008. This call is open to all investors, analysts, and members of the media. After the presentation by Vern Endo our CEO, Ed Gilpin our CFO and David Steel our Chief Risk Manager, there will be a Q&A portion of the call which is intended for the professional investment community only.

Before we begin, I would like to remind everyone that Vern, Ed, and David may make statements that constitute projections, expectations, beliefs, or similar forward-looking statements. I would like to caution you that the company’s actual results could differ materially from the results anticipated or projected in these forward-looking statements.

Additional information concerning risk factors that could cause actual results to differ materially from the information we give you today is available in our earnings release under the heading Forward-Looking Statements and the risk factor section of our 10-K for the year ended December 31, 2007.

In addition, Vernon and Ed may refer to certain non-GAAP measures in the operating earnings, core earnings, adjusted premiums written, adjusted book value, and credit impairment. For an explanation of these non-GAAP measures, including reconciliation to the most comparable GAAP measures, please also refer to our earnings release.

This call is available by live and archived webcasts in the Investor Information section of our website. I would like to remind you that if you access the archived webcast at a later date, more recent information about the company may have subsequently been released or filed with the Securities and Exchange Commission.

Now I will turn the call over to Vern Endo, Chief Executive Officer.

Vernon Endo

Good afternoon and welcome to the first quarter 2008 earnings call of RAM Holdings. With me is Ed Gilpin our CFO and David Steel our Chief Risk Manager. I will provide an overview of significant developments and discuss our outlook. Ed will present our financial results, and David will review our insured portfolio, including the updated portfolio disclosure on our web site. We will then open it up for questions.

The key development for the quarter, as most of you know by now, is the financial guarantee industry continued to report disappointing results, as the impact of the deteriorating US residential mortgage market continued to unfold. Delinquencies increased, although at a somewhat slower rate, and portfolio losses rose. Credit spreads widened and additional credit reserves and impairments were recognized.

RAM Re experienced the same developments and reported increased case and unallocated reserves with $30.5 million, and additional CDO impairments of $12.4 million. Meanwhile, unrealized fair value losses on credit defaults loss for the quarter increased by $166.4 million. These items resulted in RAM reporting a disappointing net loss of $189.5 million for the quarter. Ted will review our financials in more detail later in the call.

Loss reserves and impairments increased this quarter both because of increased deterioration in the R&Ds portfolios that began in the late summer of 2007 and our reassessment of the trajectory of delinquency curves based on additional seasoning of the R&Ds underwritten in 2007. We have additional seasoning overall; we now have a better understanding of future performance, and have been able to improve our loss estimates, which are based on the assumption, also used by our customers, of continued deterioration in the housing markets through early 2009.

We now have case reserves established on 50% of our 2005 to 2007 vintage [e-locks] and closed in second and impairments on 48% of our 2005 to 2007 vintage ABS CDOs. We and our seating customers have divulged an enormous amount of resources and effort in estimating losses and impairments. In fact, we added two additional staff members to our risk management team during the first quarter, retained consultants, and shifted underwriting resources to provide a system.

As you know, we establish our case reserves and impairments based on our independent analysis of the credit and the appropriateness of the amount seated to us by our customers.

As a reinsurer we benefit from the resources of the primary’s and are unique in our ability to obtain insights from all six of them, which informs our overall judgment in this area.

As I mentioned on our last call, we provide value by delivering our customers meaningful and stable rating agency capital credit. Our strategy is to create a capital cushion sufficient to with stand further deterioration in the US RMBS market, and provide our customers with a minimum capo credit of 70%. We currently provide 100% for S&T and 85% for Moody’s.

We intend to achieve that cushion by reducing our portfolio through the re-assumption of risk by our customers, re-insuring what other financial guarantee companies and through the reduced growth in our portfolio, which will be a result of more activity in the primary market.

We have been working closely with our customers on the re-assumption of certain portfolio segments and have made some progress. We believe our customers share our view that re-assumption of modest amounts of business, enabling them to preserve the capital credit we provide over the remaining seated business, is preferable to an overall reduction in the capital credit below current levels.

This process is complicated in that we assume business cannot cause our customers to exceed regulatory risk limits or other internal risk concentration, and if you can imagine, they remain cautious on reassuming business given their own capital position.

That said we hope to conclude several transactions before the end of the second quarter.

In addition, we continue to estimate that we will generate about $175 million of capital internally through portfolio pay downs, reduced writings and statutory earnings through 2009 which will further bolster our capital.

We do not expect business production in 2008 anywhere near the record bond experienced in 2007. We were pleased to renew two treaties this year. The volume under these treaties is expected to be lower than in 2007 due to limitations we have imposed on the business that qualifies for the treaty, lower participation percentages, as well as market conditions.

Two treaties were discontinued, because the customers were downgraded and are not writing business and two are scheduled for renewal discussions in the second quarter.

The modest amount of business that we have been seated so far in the current quarter is extremely profitable, meaning the premium is high relative to the capital charge imposed by the rating agencies. As I mentioned, this reduced volume of business allows us to rebuild capital as portfolio pay downs exceed the new volume, which self consumes relatively modest amounts of capital, given the selectivity employed by our customers.

We expect that 2008 will be a rebuilding year for both the industry and us. Restoring confidence is a key objective for our AAA customers. We are executing plans, as you know, towards achieving that objective in 2009, assuming, of course, no further significant and unanticipated deterioration in the Legacy US RMBS portfolio curves.

By bolstering our capital position this year we are confident that we will be well positioned to participate with our customers in the market opportunities available.

Edward Gilpin

2008 will be a year where RAM focuses on the balance sheet. We will do this in three main ways: by adequately reserving for future losses, by retro ceding certain businesses, and by accentuating the roll off of the existing books by writing lower, more profitable volume. These should combine to give RAM the capital cushion it needs to move forward with our plan of maintaining desired levels of radiating some capital credit for our clients, and being positioned to take advantage of the expected return to more normalized markets in 2009.

As mentioned, the continued deterioration of subprime and second lien RMBS assets in the first quarter of 2008 has had a material impact on our financial statements.

Net loss for the quarter ended 3/31/2008 was $189.5 million or $6.96 per share, that’s compared to net income of $14.3 million or $0.52 per share for the same quarter 2007. The main driver of this decline was an unrealized mark-to-market loss of $166.4 million or $6.11 per share, on our re-insured derivative portfolio of ABS CDOs, of which $12.4 million relates to credit impairment.

We also had net increases to reserves, both case and unallocated of $20.6 million and $9.9 million respectively in the quarter, relating to RMBS.

RAM believes, like others in the industry, that investors would be better served to rely on our loss reserve and credit impairment estimate to get a better perspective on RAM’s ultimate loss expectations.

The non-impaired portion of our mark-to-market losses are not only unrealized, but reflect exit values today, whereas we have the ability and expectation to hold them until maturity.

On an operating basis for the three months ended 3/31/08, RAM recorded a net operating loss of $39.5 million, versus operating income of $14.4 million for the quarter 2007; again, the driver being the increase in loss reserves and the impaired portion of our unrealized mark-to-market losses on AVS CDOs.

RAM Re’s GAAP book value is now $72.2 million or $2.65 per share, down from $252.3 million at year-end 2007. The decline was mostly the result of the increase in unrealized mark-to-market losses and reserves. The good news is that RAM had set up substantial reserves with case reserves of $48.5 million unallocated reserves of $30.9 million and impairment reserves of $56.8 million. We now have over $130 million reserved against our mortgage related exposures.

Book value on an operating basis, or our book after adding back the non-impaired portion of our mark, and subtracting the gain of our professional preferred would be $322.8 million or $11.85 per share.

Adjusting operating book value further for the benefit of the present value of future installment premiums and the value of our unearned premium reserves, plus deferred policy acquisition costs or what we call operating adjusted book value is $651.3 million or $23.90 per share.

Adjusted gross premium for the quarter ended 3/31/08 was still strong, as we recorded $41.2 million of ADP versus $26.9 million for the same quarter in the prior year. We would expect this number to start to decline in subsequent quarters due to rating agency capital constraints on our primary insurers as well as RAM’s own capital constraints and an expected decrease in the writing of structured finance business by the primary.

This is not a bad outcome for RAM as the lower volume will free up capital as our existing book of business continues to deleverage and is replaced by higher returning, lower par written business.

The first quarter 2008 also introduces two changes in our financial statement: one, change in presentation of credit default slots and the other, the adoption of FAS 157 fair value measurement. The change in presentation was to separate net derivative income into its own line on the income statement. This is now labeled change in fair value of credit derivatives and listed on the line Realized Gains and Losses and Other Settlement. Installment premiums received, less related acquisition costs on derivative contracts are recorded in this line item and are no longer included in the Premiums Rating and Earn Line in the Statement of Operations.

With the adoption of FAS 157 RAM must also take into account its own credit worthiness when determining the fair value of our derivative assets and liabilities and make an adjustment to the fair value based on this assessment. We believe this adds more complexity to investors fully understanding our risk position, which is why we think focusing on impairments is a more appropriate exercise.

To determine RAM’s credit worthiness we do not have the luxury of simply observing credit default spreads on RAM, since there is no market for such securities. We therefore look at fully observable metrics, which include ratings, market value of our committed preferred share facility, radiance in expected losses and stock price movement to determine a proxy for RAM’s own credit worthiness.

As such, we took a benefit of $110.5 million on our fair value calculations in the first quarter of 2008. The process we use in recording our marks on derivative contract involves first obtaining the marks from the seating primary companies, we then adjust these marks, when necessary, to remove the effects of the primary’s own FAS 157 non-performance risk adjustment to get to a gross mark and then adjust that gross mark for RAM’s credit worthiness assessment.

There has been some focus on holding company liquidity. Let me say that RAM currently has enough liquidity to cover all its obligations, both debt service and preferred dividends so they meet at a year. The company, barring further dramatic deterioration in the credit market, still has quite a lot of latitude in declaring dividends from its operating sub RAM Re, so we see no liquidity issues for the foreseeable future.

David Steel

My comments today will be mostly focused on the two sectors of our portfolio that have been adversely impacted by the stress in the US residential mortgage markets over the past nine months. Our US residential, mortgage backed securities RMBS sector and our acid backed CDO or ABS CDO sector.

As Vern indicated, we continue to see deterioration in the performance of these two sectors and thus we have added to our cases of impairments in the first quarter. I will discuss this performance and the analysis that led us to increase our reserves in a moment, but first I would like to review the credit quality of our overall insured portfolio apart from the two troubled sectors.

Allow me to direct your attention to our disclosure relating to our new business written in our portfolio composition found on pages 12-16 of our operating supplement, which is posted on our website.

As of March 31, our total portfolio has $48.7 billion par outstanding. We have a very diverse portfolio built upon a solid core of low risk, public finance exposures written over the ten years that we have been in business. The average rating our portfolio is A+, even including the two troubled sectors, the US RMBS and ABS CDO.

Total US and international public finance constitutes nearly 60% of our overall portfolio and stands a broad spectrum of public finance sector, including GOs, tax backed, transportation, utilities, healthcare, and several other sectors, both domestic and international.

Our international public finance exposures are predominantly from highly rated, well-developed countries.

Occasionally we do have credit down grades and defaults in the public finance sector, but historically losses have been low on public finance deals. A well-publicized example of this was Euro Tunnel, which was restructured last year with no ultimate loss. Another well-publicized example, currently in process, is Jefferson County Alabama sewer. We have $84 million par exposures in Jefferson County sewer. The counties problems stem from failed auctions and remarketing of auction rate and variable rate demand obligations due to insurer down grades and the failure of the county to raise sewer rates to meet its debt covenant.

The county, the insurers, and the banks, have all proposed restructuring plans and we are optimistic that a restructuring will occur, but we anticipate this may take some time to be completed. There is the possibility of claim payments on this credit, but at this time we do not anticipate an ultimate loss.

Our structured finance exposure apart from the US RMBS and ABS CDO segments of our portfolio include well-performing segments such as AAA, CDOs of diverse corporate exposures, AAA super senior CDOs, a diverse commercial mortgage backed securities and securitizations of various consumer and other commercial acid backs.

Excluding the two troubled sectors, over 80% of our portfolio, our structured finance part of our portfolio is rated A, or better, and only approximately ½ of 1% is below investment grade.

Our structured finance exposures are relatively granular with the largest single exposure being less than 40 basis points of our total portfolio. We’ve recently reviewed the CLO and CMDF sectors of our structured finance portfolio and are currently comfortable with the performance of these sectors.

Now, I’d like to review the sectors within our portfolio that have been adversely impacted by the stress in the US residential mortgage market, our exposures to US RMBS and ABS CDOs.

We’ve recently posted an update on these exposures on our website under Investor Information and also under Exposure Information and Updates. In this section of our website you will find a report entitled RAM Re mortgage and CDO exposure overview.

Starting with RMBS, as you can see from the first page of our disclosure, our total RMBS is $3.4 billion, including approximately $900 million of international RMBS. We have been reviewing the recent trends of home prices internationally and are aware of the recent run up and subsequent softening in some markets, particularly in the UK; however, our international RMBS is predominantly structured with loss coverage to AA or AAA levels and backed by prime quality borrowers. As a result, we are comfortable with the structures and the expected performance of our international RMBS, even with the current outlook for home prices.

Our US RMBS exposure is approximately $2.5 billion, of which approximately $2.1 billion is from the ’05 to ’07 vintages. This is shown in the table entitled Mortgage Securities Exposure on page 2 of our website report.

This table shows that our ’05 to ’07 vintage below investment grade RMBS exposure is $673 million and consists of he lock and closed-end second. In the first quarter we downgraded to below investment grade an additional $80 million of HELOCs and $162 million of closed-end segments. The downgrades of he lock deals were driven largely by an unanticipated slow down in draws by borrowers on their credit line, which in some cases is due to the servicer terminating the borrower’s right to make additional draws.

In he lock deals, when the securitization hit the rapid amortization trigger, additional draws are funded by the servicer and are subordinate to the insured securities, thus providing additional credit enhancement to cover losses; so a healthy draw rate provides more loss coverage and is indicative of a stronger deal from our perspective.

The recent slow down in draw rates led us to downgrade some of the he lock deals and to add to our case reserves for these deals in the first quarter.

As I mentioned, we also downgraded $152 million of closed-end segments to below investment grade in the first quarter. This increase in par amount of below investment grade closed-end segments increased our below investment grade closed-end segments from $31 million at year end ’07, to $192 million as of the end of the first quarter: this was primarily due to further seasoning of the closed-end second exposures, which are largely from the ’07 vintage and thus transactions where we have more limited performance data.

In recent moths the trajectory of delinquencies has become more apparent and provides a better indication of the loss curve to be expected on this product.

It should be noted that closed-end second product includes securitization backed by both prime and non-prime borrowers. The rating agencies have noted that lifetime cool offs on closed-end second deals could ultimately fall within a very wide range depending upon whether the borrowers are prime or non-prime. We concur with this assessment.

In our portfolio most of our closed-end second borrowers are prime. What non-prime we do have is nearly all reserved against now or in the AA or AAA rating bucket. The non-prime closed-end segments were a significant driver of the increase to our case reserves, as well as our unallocated reserves in the first quarter.

As of the quarter end we performed a review of all our RMBS exposures within our portfolio for the purpose of determining our reserves and as a result of our review we added $28 million of new case reserves for the ’05 to ’07 vintage HELOCs and closed-end segments. We paid claims on this product to approximately $7 million in the quarter, so that resulted in a net increase of $21 million of case reserves.

As of quarter end we have 28 he lock deals and 10 closed-end second deals from the ’05 to ’07 vintages totaling $600 million for which we established case reserves in the amount of approximately $47 million. In addition to this, we have about $1.5 million of additional reserves for losses on older vintage RMBS, which as been in place for several quarters.

Furthermore, as Ed mentioned, we increased our unallocated loss reserves by approximately $10 million in the quarter, to provide for additional RMBS losses that are not yet identified. Unallocated loss reserves available to be allocated to RMBS losses now total approximately $31 million.

A helpful way to look at this is that we now have $47 million of case reserves established for approximately $600 million or half of our total par exposure to the ’05 to ’07 vintage HELOCs and closed-end segments and we have unallocated reserves of $31 million available for the remaining half or the remaining $600 million of the ’05 to ’07 vintage HELOCs and closed-end segments.

All together, we believe that our current and prior quarter loss provisions provide sufficient reserves to absorb RMBS losses for the foreseeable future.

Following the quarter end we had discussions with each of the primary’s, as we normally do, in order to understand their concerns with each of the transactions and their loss forecasting methodology and assumptions, as well as the case reserves they have established.

We also performed our own analysis of each of our exposures. In general, when we find that the reserves established by the primary’s are in line with our own estimates, we will typically establish the primary’s reserve as our own, but when our own analysis results in a higher reserve, we typically use the results of our own analysis; so as a result, as of 03/31, our case reserves for the ’05 to ’07 vintage RMBS are approximately 10% higher than the case reserves established by the primary’s.

Our own loss forecasting analysis and the analysis of the primary’s assumes that default and losses on RMDS continue near the current heightened rate through 2008 and into early 2009. The default curve varies deal by deal but, in general, theirs seem to decline over a year-long period starting in early 2009 as the worst borrowers in the pools default out and as the economy recovers. This is a basic assumption generally shared by all the primary’s that will be born out over the next year or two.

In monitoring the delinquencies on all our deals, we are seeing some recent slowing of the growth of early stage delinquencies and many HELOCs and closed-end second and also subprime deals, which may indicate that a burn out of default rates is starting; however, there’s not enough data at this time to establish a clear trend of declining early stage delinquencies.

While we’re on the topic of FMBS, I want to mention that we have not downgraded any direct subprime RMBS transactions to below investment grade and are monitoring them carefully for signs of deterioration, particularly the BBB rated deals.

During the first quarter we downgraded a $94 million subprime securitization from A to BBB due to rising delinquencies; however, we do not currently expect to pay claims on this deal or any of our subprime RMBS exposures and have not established case reserves for any of them.

I would also like to add that we have seen rising delinquencies on Alt A RMBS recently and the Alt A product is not showing the same flowing of early stage delinquencies as the other RMBS types; however, our Alt A exposures are currently rated A or better and predominantly AAA, and thus, we do not currently expect to pay claims on any of our Alt A RMB and have not established case reserves for them.

Now turning to ABS CDOs:

The table at the top of page 5 on our website posting provides deal-by-deal detail on our ’05 to ’07 vintage ADS CDO exposures including the RAM Re rating of each of the exposures.

Of the total $1.2 billion, the outstanding par of below investment grade deals, among our ABS CDOs remains the same as last quarter at $586 million. In the quarter we increased our credit impairment for this exposure from $44.4 million to $56.8 million. Nearly all of the increase in credit impairments recognized in this quarter is related to one 2007 vintage CDO of CDO or CDO squared transaction listed at the bottom of the table on page 5 with an outstanding par of $150 million. The increase in impairment for this deal is primarily due to our increased concern regarding losses on CDO collateral within each of our CDO exposures, also known as inner CDO collateral.

To appropriately forecast losses on ABS CDOs assumptions must be made as to the portion of inner CDOs that will experience an event of default, which could result in either a shut-off of the cash flow payments on that inner CDO or a liquidation of the inner CDO on the loss. Based on reports of an increase in the frequency of inner CDO defaults, we increased our inner CDO default assumption and our credit impairment for this CDO squared.

Our ABS CDO impairments are in line with the impairments established for our deals by the primary’s.

All of our ABS CDOs were written as credit defaults sub contracts with payment terms structured to avoid significant one time claims. Our high-grade ABS CDOs provide for timely payment of interest and ultimate payment of principle; as a result, claims are not anticipated to occur for several years. Claims relating to interest payment shortfalls are anticipated to begin in 19 years, while principle payment claims are generally not anticipated to occur until maturity in 30 to 40 years.

The 2007 CDO squared transaction has different payment terms than our other eight high-grade ABS CDOs. This is a synthetic CDO with a deductible that requires that we make payments upon settlement of individual collateral losses as they occur, after the deductible is depleted. Claims on this CDO are anticipated to begin in one to two years and to continue for the next three to four years primarily.

Before I wrap up, I would like to point out that as part of our reinsurance relationship with the primary’s, they provide us the benefit of their extensive surveillance, loss forecasting, and loss mitigation capabilities. We assumed our RMBS and ABS CDO exposures from multiple primary’s and our exposures, like much of our overall portfolio, tend to be relatively granular.

Although our total RMBS and ABS CDOs from the ’05 to ’07 vintages, the weighted average seated percentage is approximately 6% as our treaties require significant retention by the primary’s. Due to this retention we believe the primary’s interests and ours are aligned and they will do everything they possibly can to mitigate losses on the deals.

Currently each of the primary’s are in various stages of reviewing the borrower loan documentation, lender underwriting practices, and transaction reps, warranties and covenants to determine their ability to mitigate losses by requiring the lenders to repurchase defaulted loans. Some repurchases have occurred already and many more are in process. At this time, however, our case reserves and impairments do not take into consideration the potential benefit of loss mitigation by the primary’s.

To summarize, our portfolio apart from the troubled sectors remains diverse and performing well. In the first quarter we made significant additions to our case reserves and impairments, in some cases beyond the case reserves posted by the primary’s, and we also added to our unallocated reserves for potential additional RMBS loss activity where specific reserves cannot yet be estimated.

We remain cautious remaining subprime and Alt A, RMBS, but do not currently forecast losses on these sectors, and we are closely monitoring the effects of events that default on inner CDOs. Our case reserves and impairments are our best estimate of probable and estimable losses and absent further changes to our performance assumptions, we believe we have established adequate reserves overall for the foreseeable future.

………..

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Gary Ransom with Fox-Pitt, Kelton.

Gary Ransom - Fox-Pitt, Kelton

I had a question on your reinsurance treaties. There are at least two of your clients that have ongoing business volume coming through. I just wondered, you mentioned, Vern, that there might be some restrictions in what you were taking and I was just wondering what it might mean, particularly for those two reinsured customers.

Vernon Endo

Well effectively, what it means is that they can seat us lower amounts of business generally and we’re doing that to obviously protect our capital position and the restrictions also included limiting the amount of high-capital charge business that comes through.

Gary Ransom - Fox-Pitt, Kelton

Are those the two treaties that renew in the second quarter?

Vernon Endo

No.

Gary Ransom - Fox-Pitt, Kelton

No, so both those treaties have renewed in the first quarter?

Vernon Endo

Yes.

Gary Ransom - Fox-Pitt, Kelton

Yes, okay. You calculated a book value excluding the mark. I think you said $11.80, what was that number?

Vernon Endo

Yes, that was actually our book value less the portion of the markets not seemed to be impaired, so it’s the non-impaired portion of the mark, $11.85.

Gary Ransom - Fox-Pitt, Kelton

You also mentioned that you thought there could be several transactions where you are undoing some of the reinsurance treaty in terms of volume. Would that be across the board, or would it be, in essence, a deal that would take a broader array of the business and then put it back, or would it just be the better parts of the business where there’s no obvious losses?

Vernon Endo

What we’re working on is it will be a mix of business, but it will just tend to be higher capital charge business, not necessarily any particular sector.

Gary Ransom - Fox-Pitt, Kelton

So to the extent that any of it has losses, would you be seating back to them some of the ones where you actually have booked losses and is there a negotiation involved in how big those losses are?

Vernon Endo

Yes, we have had some of those discussions, but that’s not contemplated at this time.

Operator

Your next question comes from Joseph DeMarino with Piper Jaffray.

Joseph DeMarino - Piper Jaffray

Could you comment on whether or not you’ve seen any early indication of improvement in April and May on your HELOC and closed-end second books? What has been the general performance so far after the first quarter?

Vernon Endo

We have seen at the end of the first quarter and April a decline in the increase of the early stage delinquencies that means 30-days and 60-day delinquencies or closed-end seconds in HELOCs. We have seen that slowing down, or the curve flattening out. It’s a couple of months, but I would caution that a couple of months doesn’t necessarily make a trend.

Joseph DeMarino - Piper Jaffray

Regarding HELOCs and closed-end seconds again, is the ’07 vintage, now that you have considerably more data points to look at, is that shaping out to look more like ’06 is? Can you compare and contrast ’06 and ’07 a little bit?

Vernon Endo

I would say that we tend to have more closed-end seconds from ’07 and more HELOCs from ’06, so you’re kind of comparing one product to another. What we saw in the first quarter and a month after that was that the closed-end seconds from ’07 started to catch up to the delinquencies of the HELOCs from ’06 and that’s what caused us to add closed-end seconds from ’07 to our below investment grade category and add the case reserves against the ’07 closed-end seconds.

Joseph DeMarino - Piper Jaffray

Could you provide a little more detail on some of the retro session opportunities you mentioned?

Vernon Endo

Well they’re really under negotiation now, so we really can’t share much more than what we said so far and that is, our primary customers not reassuming books of business that have losses in them. They’re not taking back business that is necessarily across the board, but the business that we’re looking at is business that has relatively high capital charge, but performing. By taking back a modest amount of that business it can really help us in respect of our rating agency capital.

Operator

Your next question comes from Allan Seymour with Columbia Management.

Allan Seymour - Columbia Management

Do you have any sense as to whether they’re, I don’t know if there is, but the bank guys talked about loan-to-value on their HELOCs. Do you have any sense of what the portfolios are for you?

The second question is, if the primary’s were to lose their AAA rating is there any implication on that for you?

Edward Gilpin

I’ll take the first question about loan-to-value ratios on HELOCs tend to be approximately 85%, that’s combined. Of course those are the second liens of combined first and second liens and they tend to be prime borrowers with FICOs in the 700+ area. I think I mentioned that we do have a small amount of deals that have lower FICOs that I would consider non-prime, below 700 and so we’re watching that part very closely and have more reserves against that.

Vernon Endo

In respect of what happens if the primary customers are down graded, we have two examples: what normally happens is they stop writing business, and as I mentioned in my remarks, because they stop writing business they really don’t need reinsurance of the kind that we provide, which is sort of ongoing reinsurance for new transactions and so in two cases earlier this year those treaties were discontinued. Other than that there really are no other implications for us.

Allan Seymour - Columbia Management

So they don’t necessarily have to keep the AAA rating for you to reinsure them as part of your contract?

Vernon Endo

No, no.

Edward Gilpin

Just so we’re clear, the treaties that we renewed are with customers who have AAA ratings from both Moody’s and S&P and the two customers who were down graded, those treaties were discontinued. Then the other two customers still have the AAA ratings from both Moody’s and S&P and those renewal discussions are going to get started pretty quickly.

Operator

Your next question comes from Rick Sherman with Oppenheimer & Co.

Rick Sherman - Oppenheimer & Co.

When you were discussing your book value, part of the way you got to your book value was by taking the current market value of your preferred securities and adding that back in, did I hear that correctly?

Edward Gilpin

It was actually that I backed it back out. In other words our perpetual preferreds are at a gain on the income statement and I backed up the effect of that gain.

Rick Sherman - Oppenheimer & Co.

I’m still a little confused. What effect did that, you’re talking about the preferreds that you issued, their current market value is now at a discount to par I would assume; is that correct?

Edward Gilpin

Yes, but that’s actually a gain for us because we actually issued them again. Today it would cost us a lot more so we have the ability to put those contracts in terms of into preferred stock; it shows up as a gain on our income statement. There is actually a separate line for it on the income statement which says Other Financial Assets.

Rick Sherman - Oppenheimer & Co.

So the $75 million of preferred you have outstanding, I’m a little confused. Do you have some way to put that to somebody, or did you write a derivative contract against it, or it’s hedged, or how did that work?

Edward Gilpin

Yes, it’s a perpetual preferred, it’s a floating-rate, no-rate loan, but you have the right to convert it to preferred stock and because of that ability to put that to them as preferred stock, you have to fair value like a derivative and it shows up on our income statement as with its fair value.

Frankly, we’ve said in other public statements that it’s not really a gain that we think we can actually achieve. There are a lot of reasons why it would be hard for us to actually realize that gain, but as derivative accounting it shows up on the income statement.

Rick Sherman - Oppenheimer & Co.

So if you pulled that out, if it didn’t exist, then what are you calculating as the book value?

Edward Gilpin

Well for the book values, I gave you three different things: I gave you book value, which is $265 a share, stated GAAP book value; and the next thing I gave you was operating book value, which is where you take that $265 per share, you add back the portion of our unrealized mark-to-market losses, which we don’t deem to be impaired; and then I subtracted out the gain that’s on the income statement related to our potential preferreds.

Rick Sherman - Oppenheimer & Co.

That number is the one that came to $11 and change?

Edward Gilpin

That’s the $11.85 and the third one I gave you is what I called adjusted operating book value, which is taking that $11.85 and then adding to that the present value of future installment premiums that we expect to earn over their life, less the deferred policy acquisition costs that we would have to bring into the expenses forward and that gets you to $23.90 per share.

Rick Sherman - Oppenheimer & Co.

Did I hear correctly in the original opening comments about the plans for the rest of ’08 into ’09, based on the way the stocks raised and everything, your survivability is constantly being marked to the market in the marketplace every day. I should say this; I say this as somebody who is long with stocks so, I say it in a constructive way.

The thing I don’t understand is, I think I heard that you have no intention of really raising any capital through any external source other than basically through run off and there were three things I believe that you commented on . None of them, though, was talking about doing anything dilution in any way based on selling any securities at the current time.

You were going to build a portfolio of $175 million or so over the next 12 months or so through other means. Did I hear that correctly?

Edward Gilpin

That’s correct; we are not planning any dilutive action.

Rick Sherman - Oppenheimer & Co.

Can I ask you something just a little hypothetical? What pretty much keeps you up at night as to what can go wrong? Obviously nobody knows when the housing slide and other things in the economy are going to turn around, but what are some of the things that could give somebody comfort that you’re a prepared, I know you’re reserving more etc… but, that you’re prepared for this to go on and continue, to probably get worse for, let’s say, another six or nine months?

Edward Gilpin

We did our analysis on our troubled portfolio assuming that the housing market doesn’t recover, it continues to decline and then starts to recover a bit in ’09, so we feel pretty good about that. I think the thing we’re cautious on is we’re looking at the other related RMDS factors. David mentioned we’ve got one subprime transaction that we put on our watch list, $90 some odd million that we’re watching carefully and the other is the performance of Alt A mortgages, but we seem to feel that that so far looks ok, because most of that is AAA rated, AA and AAA rated.

Rick Sherman - Oppenheimer & Co.

Speaking to that that you just mentioned, one of the largest purveyors of Alt A mortgages is like IndyMac Bank Corp, things like that. They are all reporting tremendous deterioration, even with high credit score borrowers, but that is really starting to decline. Then Fannie Mae, just today is predicting pretty much a 20% to 25% overall decline in housing prices before it’s all over on a nation wide basis.

The fact that you don’t have any reserves against Alt A, is it fair to say that that’s realistic, or is it where you are in the senior level of it, where that’s why you feel you’re protected?

Edward Gilpin

That’s really it, what you just said there at the end; because the deals that we have that are Alt A were structured to AA and AAA loss coverage levels going in. I think that the primary’s realize with that product that there was volatility and it historically performed very well. They’re high prime quality borrowers, but they are called Alt A because of the low documentation which can lead to some volatility.

The primary structures of those deals, so that they had ample first loss protection at an AA, AAA level and so as we go into this stress scenario, we think that that’s enough to cover losses. That’s why we don’t have any reserves against those.

Rick Sherman - Oppenheimer & Co.

Are those structured to where as the defaults go up, the guys at the various lower trounces get shut off completely and then all income and everything from that is going to flow to whoever is at the senior secured level and then on down?

Edward Gilpin

There is a variety of deal features and triggers, but yes that would be the case that the senior loans get paid off down first and get off first.

Rick Sherman - Oppenheimer & Co.

The ones you’re insuring though, do they have the controlling interest when this starts happening? Are you at that level?

Edward Gilpin

These deals are simpler than that. They’re just automatically built that way. You don’t need to exercise any particular vote or anything to have that happen.

Operator

Your next question comes from David [Hepperman] with GSC.

David [Hepperman] - GSC

Can you please walk through a scenario where RAM is downgraded with respect to what alternatives primary’s would have to reclaim business they’ve already seeded to RAM, to what extent they can cherry pick good and bad business either by vintage, by sector etc…?

Edward Gilpin

Yes, I’ll give you broadly what that means. If we’re downgraded, certain of the primary company’s have rights to take back some of the business. Again, typically they can’t cherry pick, they have to take back by vintage year, or they have to take all or nothing, so it’s not as easy as that.

The other thing is, their options are, certainly if we get downgraded they still get, depending on what we’re downgraded to in this hypothetical scenario, they still get significant capital credits. It’s likely that they won’t do anything at first. We’ve talked to most of them and they’re interested in keeping it with us as long as they’re getting some significant capital credit. Yes, they do have rights under their treaties to take back business, but again, it’s typically by vintage year or all or none.

David [Hepperman] - GSC

Just to be clear, if they wanted to take back 2006 public finance business in total, they would also have to take residential mortgage and CDO business with that?

Edward Gilpin

Yes if they want to take back 2006 they have to take back everything from 2006, not just public finance.

David [Hepperman] - GSC

But, they could pick 2002 and that’s a great year, and they could say, we want all of 2002 back, but we want to keep every other relationship going?

Edward Gilpin

Well again, not everybody’s the same. Some can, some can’t. Some have to take everything they’ve ever given us; some have vintage year, but yes if they had that stipulation they could take back 2002.

Operator

Your last question comes from Orin McCluskey with Equity Value Venture.

Orin McCluskey - Equity Value Venture

I’m looking to [indiscernible] structure to [indiscernible]

Vernon Endo

I’m sorry; could I just interrupt for a minute? I’m having a very hard time hearing.

Orin McCluskey - Equity Value Venture

I’m trying to compare to your 10-K. I’m looking at your category four structured finance page, which showed a year-end total category for $923.5 million and when it was broken down further by the amount of HELOCs and CES in that category and the reserves against those exposures. Are those figures updated on your website or can you give them to me?

Vernon Endo

The watch list categories are not updated on the website. What you will find on the website is our ratings and so you can compare the low investment grade rated HELOCs and closed-end seconds at year-end to the below investment grade HELOCs and closed-end seconds as of 3/31 by looking at the 10-K that you’re looking at and also looking at what’s on our website disclosure.

Orin McCluskey - Equity Value Venture

Do you give out a category four figure every quarter or not?

Edward Gilpin

No, we typically do not give that out every quarter. Category four does tend to track our deals that have case reserves and we typically do not provide that, but I can give you a number. We are now at $1.03, $1.04 billion. As you said we were at $923 million at the end of the year.

Orin McCluskey - Equity Value Venture

Do the other figures more or less match it up proportionately?

Edward Gilpin

We had a decline in our category one and we had a lot of movement from category one and two to a category three.

Vernon Endo

Thank you for joining us this afternoon and we look forward to talking with you again next quarter.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!