Good day, ladies and gentlemen, welcome to the second quarter 2015 Arch Capital Group earnings conference call. My name is Crystal, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question and answer towards the end of the conference. If at any time during the call you require assistance, please press star and the operator will be happy to assist you. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied.
For more information on the risk and other factors that may affect future performance, investors should review periodic reports that are filed by the companies with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make reference to some non-GAAP measures of financial performance. The reconciliation to GAAP and definition of operating income can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings-
Thank you for joining us today. Our second quarter earnings were driven by solid reporter underwriting results, while investment returns were impacted by the recent rise in interest rates. On a group-wide basis, our gross written premium declined by 8% in the quarter, while our net written premium decreased by 10.5% as underwriting actions and rate decreases in our insurance and reinsurance businesses offset growth in our mortgage business. Changes in foreign exchange rates also reduced our net written premium on a U.S. dollar basis by $22 million or approximately 2.4% of our volume in the quarter. On an operating basis, we earned $146 million or $1.16 per share for the second quarter, which produced an annualized return on equity of 9.9% for the 2015 second quarter versus an 11.2% return in the second quarter of 2014.
On a net income basis, Arch earned $0.88 per share this quarter, which was lower than operating income, primarily due to foreign exchange and realized investment losses. On a trailing 12-month basis, net income produced a 14% return on equity. Net income movements on a quarterly basis can be more volatile as these earnings are influenced by change in foreign exchange rates and gains and losses in our investment portfolio. Our reported underwriting results remain solid as reflected in our combined ratio of 87.9% and were aided by a low level of catastrophe losses and continued favorable loss reserve development. Net investment income per share for the quarter was $0.53 per share, down $0.02 sequentially from the first quarter 2015 due to the short-term effects of share repurchases on investable assets during the quarter.
Our operating cash flow was $232 million in the second quarter as compared to $254 million in the same period last year, primarily reflecting reduced net premiums writings over the past six months. Our book value per common share at June 30th, 2015, was $47.49 per share, a slight decrease from March 31, 2015, and an increase of 8.6% from the $43.73 per share at June 30, 2014. With respect to capital management, we continue to have capital in excess of our target levels. In the second quarter, we repurchased 3.2 million shares for an aggregate purchase price of $199 million. I would like to take this opportunity to review our philosophy on capital management. As always, our preference is to deploy capital in our businesses.
If business conditions don't allow us to earn our target returns, we will look to return excess capital to our shareholders, either through share repurchases or special dividends. Generally, we prefer share repurchases, which benefit shareholders over the long term by increasing earnings per share. When our shares trade at a premium to book, as they have for some time now, we have to be prudent in those decisions. You have seen the grid on our website, but the essence of this chart is that when we purchase our shares at a premium to book value, our objective is to earn back that premium for our shareholders over a reasonable period based on the expected returns that we can achieve on equity. Whether we can earn that premium back or not is dependent on how quickly the company generates earnings.
One can have a different point of view on this, but in the current environment, we think that after three years, our crystal ball becomes very foggy. Current competitive conditions make profitable growth in our traditional lines of insurance and reinsurance difficult to achieve, and not surprisingly, the industry is experiencing an elevated level of M&A activity. In anticipation of your questions, I would like to take a moment to reiterate our thinking with respect to acquisitions. We like to investigate opportunities presented by the marketplace, but our preference is to invest first in the recruitment of people and teams with specialty expertise that will complement our product platform. Our second choice would be renewal rights transactions, and last are acquisitions of business units. We consider acquisitions of business to be the most difficult because, by their nature, they involve greater uncertainty.
The criteria that we use in evaluating potential acquisitions have not changed. First and foremost, the business should be complementary to our long-term strategic goals. Second, there needs to be a cultural fit. Does management have similar DNA to Arch? That's very critical and very important to us. Third, is the balance sheet transparent and we can get our arms around it? When all those three conditions are met, we look at price last. As respects to price, similar to our approach on share repurchases, we consider, among other things, the length of time and the relative certainty it will take to recover any premium to book value paid. With respect to overall market conditions, it is starting to feel like the late 1990s, where reinsurance is available at attractive prices and where favorable terms to the buyer are easily obtained.
We have not yet seen significant erosion in the insurance business, with the exception of certain lines, which I will discuss in a moment. We believe, however, that the ability to buy reinsurance on favorable terms will eventually lead to more competitive conditions across the insurance business. As I indicated, there are several areas in the insurance sectors that are experiencing increasingly severe price competition. They are E&S and large global property markets, professional liability lines, including D&O, especially in foreign markets, as well as marine aviation and energy. In all these business lines, we have significantly reduced our exposure. At Arch, underwriting discipline has always been the foundation of our success, and it will continue to be the number one priority and focus of our management team.
Over our history, we have built underwriting systems and controls which allow us to monitor not only changes in premium rates, but also changes in terms and conditions. We believe that our culture and systems in combination should allow us to better navigate phases of the property casualty cycle. Turning back to our quarterly results, the insurance segment gross and net written premiums on a constant dollar basis fell 11.1% and 10.7% in the quarter compared to over the same quarter in 2014, partially due to the timing of certain renewal businesses obtained in a renewal rights transaction in our alternative markets business that we have discussed in previous calls. Volume was affected by underwriting actions in our international and program units. Marc will comment further on premium volume in a few minutes.
In our reinsurance segment, softening pricing and continued pressures on terms and conditions led us to reduce on a constant dollar basis net written premium by 8.3%. Purchases of retro protection reduced net premiums volume in the quarter. Our mortgage segment includes primary mortgage insurance written through Arch MI in the U.S., reinsurance treaties covering mortgage risk written globally, as well as other risk-sharing transactions. Gross written premium in the mortgage segment were $68.6 million in the second quarter 2015, or nearly 24% higher than in the same quarter of 2014. Net written premium grew 22% over the same period to $61.7 million.
Our U.S. mortgage insurance operations acquired in late 2014 produce approximately half of the segment's net written premium in the second quarter, with $24 million of net premium written in the credit union channel where the bank channel produced $7 million of premiums written for the quarter. We continue to make good progress in the expansion of the bank channel and have approved more than 748 master policy applications from banks, and more than 264 of these banks have already submitted loans for our approval. Of these master policies, 40 represent national accounts and the balance are regional banks. We also continue to see opportunities in GSE risk-sharing transactions, which produced $3.7 million of other underwriting income for the 2015 second quarter versus $1.2 million in the same quarter of 2014. No premium was reported for these transactions as current accounting treatment requires us to continue to use derivative accounting.
We fully expect that future transactions involving Fannie Mae and Freddie Mac will receive insurance accounting treatment. Although competitive pricing conditions have intensified a bit, our strong balance sheet, diversified mix of business, and our willingness to exercise underwriting discipline should allow us to continue to generate acceptable returns. Group-wide, on an expected basis, we believe the present value ROE on the business we wrote this year for six months will produce an underwriting year return on equity in the range of 10%-12%. Now, before I turn it over to Marc, I would like to discuss our cat PMLs. As usual, I would like to point out that our cat PML aggregates reflect business bound through July 1st, while the premium numbers included in our financial statements are through June 30th, and that the PMLs are reflected net of reinsurance purchases and retrocessions.
As of July 1st, 2015, our largest 250-year single event PML was essentially flat and is in the Northeast at $541 million, or approximately 9% of common shareholders' equity. Our Gulf of Mexico PML increased slightly to $522 million on July 1st, and our Florida Tri-County PML stands at $445 million, a slight increase. I will now turn it over to Marc to comment further on our financial results, and when Marc concludes his prepared remarks, we'll come back and take your questions. Marc?
Great. Thank you, Dinos, and good morning to all. As is true on last quarter's call, my comments that follow today are on a pure Arch basis, which excludes the other segment, that being Watford Re, unless otherwise noted. As in previous calls, I will be using the term core to denote results without Watford Re and the term consolidated when discussing results, including Watford Re. Okay. Now with that said, the core combined ratio for this quarter was 87.9%, with 1.9 points of current accident year cat related events, net of reinsurance and reinstatement premiums, compared to the 2014 second quarter combined ratio of 86.2%, which reflected 1.8 points of cat related events. Losses recorded in the second quarter from these cat events, net of recoverables and reinstatement premiums, totaled $15.9 million versus $16.5 million in the corresponding quarter last year.
This quarter's cats primarily emanated from U.S. spring tornado and thunderstorm events and some Australian weather activity. The 2015 second quarter core combined ratio reflected 9.2 points of prior year net favorable development, net of reinsurance and related acquisition expenses, compared to 9.4 points of prior period favorable development on the same basis in 2014's corresponding quarter. This results in a core accident quarter combined ratio excluding cats for the second quarter of 2015 of 95.2%, compared to the 93.8% accident quarter combined ratio in the second quarter of 2014. In the insurance segment, the 2015 accident quarter combined ratio excluding cats was 97.6%, compared to an accident quarter combined ratio of 95.9% a year ago.
This 170 basis point increase was driven by 120 bips in the loss ratio and 50 bips in the expense ratio, with the loss ratio increase reflecting higher large loss attritional activity than in the second quarter of 2014, emanating primarily from aviation war and offshore energy claims. Taking this increase into account, the insurance segment accident quarter loss ratios were nearly identical this quarter versus the second quarter of 2014. The reinsurance segment 2015 accident quarter combined ratio excluding cats was 94% even compared to 92.1% in the corresponding quarter of 2014. As noted in prior quarters, the reinsurance segment's results reflect changes in the mix of premiums earned, including a lower contribution from property cat and other property businesses.
One should also note that this quarter we did receive regulatory approval for the acquisition of Gulf Re, and accordingly, have consolidated Gulf Re's results as a subset of the reinsurance segment, whereas previously it was accounted for under the equity method as a single line entry. Although its impact was immaterial this quarter. This reclassified business falls within the "property excluding property cat line" in our financial supplement. The mortgage segment 2015 accident quarter combined ratio was 77.4% compared to 84.9% for the second quarter of 2014. This decrease is predominantly driven by continued low levels of reported delinquencies benefiting the loss ratio associated with the CMG business we acquired in 2014, along with better underlying credit risk on business written since the acquisition.
The insurance segment accounted for roughly 24% of the total net favorable development this quarter, excluding the associated impact on acquisition expenses, and this was primarily driven by shorter tailed lines from the 2011-2014 accident years, with some contribution from longer tailed lines spread primarily across older accident years. The reinsurance segment accounted for approximately 75% of the total net favorable development in the quarter, with approximately 37% of that due to net favorable development on short tail lines concentrated in the more recent accident years, and the balance due to net favorable development on longer tailed lines, primarily from the 2003-2009 underwriting years. Similar to the past, approximately two-thirds of our core $7.3 billion of total net reserves for loss adjustment expense are IBNR and additional case reserves, which continues to remain fairly consistent across both reinsurance and insurance segments.
The core expense ratio for the second quarter of 2015 was 35.1% versus the prior year's comparative quarter expense ratio of 32.8%, driven by an increase in the operating expense ratio of 210 bips, along with an increase in the acquisition expense ratio of 20 bips. The increase in the operating expense ratio component reflects a 6.5% decrease in net earned premiums, a 5.7% increase in operating expenses, which also continues to reflect the addition of our U.S. mortgage insurance operations, which as we said in the past, is operating at a higher expense ratio until that business reaches steady state. However, as I will get into shortly, it is best to look at the expense ratio in totality rather than by each component separately due to the accounting for reinsurance ceding commissions.
The insurance segment's expense ratio increased 50 basis points to 32.5% for the quarter compared to 32% even a year ago. The net acquisition ratio decreased 10 basis points, whereas the operating expense ratio increased 60 basis points. This separation, as mentioned earlier, is artificial since reinsurance ceding commissions reimburse ceding companies not just for front-end acquisition expenses, but also for the overhead associated with running the primary business. In most cases, an override in addition to these reimbursements. It has been the convention to categorize the entirety of reinsurance ceding commissions in the net acquisition line, whereas a portion of these commissions contemplate operating and unallocated loss adjustment expense reimbursements but are not classified there.
The increased ceding commissions actually provide offsets to the operating expense ratio, which is why I said initially, looking at things in totality, deal with those issues as opposed to swapping it from one place to another. The insurance segment net acquisition ratio reduction primarily reflects material improved treaty ceding commissions on an earned basis associated with quota share contracts ceded. It's important to note, though, that on a written basis, the front-end gross commission ratio worldwide actually increased 40 basis points, whereas the average cede commission ratio improved substantially by 260 basis points. Taken together, this increased treaty commission benefit overcame the increase in the gross commission, resulting in a 60 basis point net commission improvement, again, on a written basis. Lastly, one has to reflect the premium tax component, which is a part of the net acquisition expense but is not considered to be commission expense.
That increased approximately 40 basis points quarter-over-quarter. That's mostly a function of mix. This reflects traditional premium taxes, second injury funds, guarantee fund costs, et cetera, which also though, signals some shift from non-admitted paper to admitted forms as the market softens. These overall net acquisition improvements, however, will continue to be felt as the ceded written premiums are earned over the next few quarters. The reinsurance segment's expense ratio increased from 30.9% in the second quarter of 2014 to 35.5% this quarter, primarily due to the lower level of net earned premiums, a higher level of treaty cede commissions associated with bound contracts, and a slight increase in operating expenses. The net acquisition ratio increased 160 basis points due to market forces, whereas the 300 basis point increase in the operating expense ratio is almost exclusively driven by the 18.4% reduction in net premiums earned.
The ratio of net premiums to gross premiums for our core operations in the quarter was 71.3% versus 73.2% a year ago. The insurance segment had a 68.3% ratio, which was very comparable to the 67.9% a year earlier, whereas the reinsurance segment had a net-to-gross ratio of 73.9% this quarter compared to 83.1% a year ago, primarily reflecting increased property and property cat retrocessions and increased cessions to Watford Re as a reinsurer. Shifting now towards the market. Our U.S. insurance operations saw an 80 basis point effective rate decrease this quarter, net of reinsurance. Commented on the last couple of quarters, the pricing environment is quite different for short-tail versus longer-tailed lines. Our short-tailed first-party lines of business had an effective 6.5% rate decrease for the quarter, compared to a 1% effective rate increase for the longer-tailed third-party lines, both on a net or reinsurance basis.
Rate increases on longer-tailed lines in the aggregate have now dropped below our view of weighted loss cost trends. Looking more deeply, some lines incurred rate reductions, such as a 10.5% decrease in property and a 5% decrease in high capacity D&O lines, while others enjoyed healthy increases, such as +6.5% in our lower capacity D&O lines, 5.5% in loss-sensitive construction, and 3% in our program business. Also, as I've mentioned on prior calls, our lower capacity D&O business lines have now achieved 16 consecutive quarters of rate increases. Turning to our continuing market cycle management. The insurance group worldwide reduced net written premiums in the volatile lines of E&S casualty, E&S property, global property, and professional liability in excess of 20% quarter-over-quarter.
Lower volatility lines of contract binding, travel, and surety expanded north of 15%, partially offset by a decline in program business due to underwriting actions. Professional liability is down due to our continuing reduction of European exposures, plus a subset of SME professional business changed its common x-date or expiration date from June into July. One anomaly to be aware of is in the U.S. alternative markets business, as Dinos alluded to, which on the surface appears to have had a 25% reduction in net written premiums, but in reality, back in the second quarter of 2014, when a previously discussed renewal rights agreement was completed, most risk wanted to attain Arch's A+ paper as soon as possible and were bound with odd-time policy terms that are now naturally renewing throughout the balance of the year.
The reinsurance group only had 8.9% of its net earned premium represented by property cat this quarter, and property cat net written premiums were reduced by another 15% quarter-over-quarter. Property other than property cat or excluding property cat, had a net written premium increase of just shy of 4% this quarter. However, this was driven by our property facultative unit. Additionally, the reinsurance group reduced net volume in motor quota share, trade credit, and crop hail by at least 20% in response to market conditions. The mortgage segment posted a 75.3% combined ratio for the calendar quarter. The expense ratio, as expected and as denoted earlier, continues to be high as the operating ratio related to our U.S. primary operation will remain elevated until that proper scale is achieved.
The net written premiums of $61.7 million in the quarter is driven by $30.6 million from our U.S. primary operations, as Dinos mentioned, and $31.1 million of net written premiums from our reinsurance mortgage operations. The segment also had $3.7 million of other underwriting income in the quarter versus approximately $1.2 million in the second quarter of 2014 due to risk-sharing transactions, which are treated as derivatives and mark-to-market each quarter. You may recall that type of income in last quarter sequentially was around a little north of $7.5 million, which incorporated some catch-up premiums that aren't reflected in this quarter. At June 30th, 2015, our risk in force of $10.7 billion includes $6.1 billion from our U.S. mortgage insurance operation, $3.9 billion through worldwide reinsurance operations, and $684 million through risk-sharing transactions.
Our primary U.S. mortgage insurance operation found $2.7 billion of new insurance written during the quarter, which was approximately evenly split between bank and credit union clients, and which statistically represents the aggregate of original principal balances of all loans receiving new coverage during the quarter. The weighted average FICO score for the U.S. primary portfolio remained strong at 735, and the weighted average loan-to-value ratio held steady at 93.2%. Those states' risk in force represents more than 10% of the portfolio, and our U.S. primary mortgage insurance company is operating at an estimated 9.7 to 1 risk to capital ratio as of June 30th, 2015. The other segment, which still as of now is exclusively Watford Re, reported 103.8% combined ratio for the quarter on $120.2 million of net written premiums and $107.2 million of net earned premiums.
As a reminder, these premiums reflect 100% of the business assumed rather than simply Arch's approximate 11% common share interest. As for business sourcing, approximately 40% of the $128 million in gross written premiums this quarter was written directly on Watford paper with the remainder seated by Arch affiliates. It should be noted, however, that this sourcing mix can vary materially quarter to quarter. The total return on our portfolio was a reported negative four basis points on a U.S. dollar basis in the quarter, primarily reflecting declines in our investment-grade fixed income portfolio driven by rising yields and widening spreads, partially offset by positive returns in our alternative investment, equity, and non-investment grade sectors. Total return also benefited from the weakening U.S. dollar on most of our foreign-denominated investments. Excluding foreign exchange, total return was a negative 38 basis points in the quarter.
Our embedded pre-tax book yield before expenses was 2.07% as of the end of the quarter, compared to 2.18% at December 31st, 2014, while the duration of the portfolio shortened to 3.05 years. The current duration continues to reflect our conservative position on interest rates in the current yield environment. Movements in duration are not necessarily indicative of longer-term strategy or of the insurance reinsurance portfolio composition due to this duration statistic being reported on a single-day balance sheet view. Reported net investment income in the quarter was $0.53 per share, or $67.2 million, versus an identical $0.53 per share in the 2014 second quarter, or $72.5 million. As always, we evaluate investment performance on a total return basis and as such, invest in asset sectors which may not generate net investment income.
Cash flow from operations for the quarter on a core basis, excluding the other segment, was approximately $232 million, compared to $254 million in the second quarter of 2014. This was caused primarily by reduced premium inflows net of commissions and net of reinsurance cessions. Interest expense for the quarter was $4 million even, which is a significant reduction from the last two quarters and from the corresponding second quarter of 2014. This reduction is due to a favorable adjustment involving a certain loss portfolio transfer entered into effective January of 2013. This deposit accounting transaction had a downward reevaluation in the quarter of the underlying ultimate loss, which resulted in an $8.4 million reduction in interest expense. As you may recall, there was a similar adjustment for this in the third quarter of 2014.
However, the run rate interest expense, which includes approximately $12 million from Arch's senior notes and a variable amount of Arch's revolving credit borrowings and some other items, is expected to be under $13 million per quarter for the foreseeable future. However, reevaluation of the underlying ultimate loss attributable to this loss portfolio transfer will occur periodically and could potentially produce significant further adjustments. Our effective tax rate on pre-tax operating income available to Arch shareholders for this quarter was an expense of 3.9%, compared to an expense of 3.6% in the second quarter of last year. There was no tax catch-up this quarter, as the tax rates on pre-tax operating income were identical for both quarters of 2015. As always, fluctuation in the effective tax rate can result from variability in the relative mix of income or loss projected by jurisdiction.
Our total capital was $7.03 billion at the end of the quarter, which is virtually flat with total capital at prior year-end, but down 2.1% relative to total capital as of March 31st of 2015. During this quarter, we repurchased 3.2 million shares, as Dinos mentioned, at an aggregate cost of approximately $199 million. These repurchases represented a multiple of 1.32x of the previous average book value and had the effect of reducing quarter-ending book value per share by $0.39. Additionally, approximately $525 million remains under our existing buyback authorization as of the end of the quarter. The effect of foreign exchange on book value was a loss of approximately $0.22 per share, as the negative impact of restating insurance and reinsurance liabilities outstripped the gain in non-U.S. denominated investments.
Our debt-to-capital ratio remains low at 12.7%, and debt plus hybrids represent only 17.3% of our total capital, which continues to give us significant financial flexibility. We also continue to estimate having capital in excess of our targeted position. Book value per share was $47.49 at the end of the quarter, down 0.6% versus the prior quarter and up 8.6% relative to one year ago. This change in book value per share this quarter primarily reflects unrealized losses and foreign exchange impacts from fixed income securities, which exceeded the company's continued strong underwriting results. Although there was a lot of activity this quarter affecting book value, we shouldn't lose sight of the fact that the $0.31 per share drop in book value can be totally explained by the $0.39 per share impact of our share buybacks this quarter.
With that and these introductory comments, we're now pleased to take your questions.
Ladies and gentlemen, at this time, if you would like to ask a question, please press star one. Questions will be taken in the order received. Please press star one to begin. Our first question will come from the line of Michael Nannizzi from Goldman Sachs. Please proceed.
Thanks. Hey, Marc. Just one question I had on the Watford premiums, maybe you alluded to this in your comments. The premiums there were higher than the ceded premiums out of the reinsurance business. Did business come from somewhere else, or was there some accounting there just to be aware of?
Well, no. We did say that 40% of that was natively on their paper, so it wouldn't have been ceded from any Arch affiliate. There was a slightly higher contribution from the insurance group this quarter than the reinsurance group. I think that answers your question.
Yep. Got it. Great. Thanks. Then, in terms of the expenses, you talked about the G&A ratio coming up just from a denominator effect of premiums being lower. Is there a level where you want that to be, or are you comfortable kind of letting the business pulling back and taking appropriate underwriting actions and holding onto your infrastructure just for the potential for conditions to change and being able to leverage that infrastructure again down the road?
Dinos and I both have an opinion on that. I'll go first on it. It's a balance beam. There's things that you need to be mindful of and be efficient and make the right tough decisions. There's other areas you have to recognize. You might be going into bone and muscle, as Dino says, our business is to make decisions. You don't want to lose that decision-making ability. There's some level of carrying intellectual property we're willing to have, irrespective of what it does to the expense ratio.
Yeah. No company went bankrupt or had significant problems because of expense ratio. Most of the companies, they have difficulty with results is due to loss ratio. In echoing what Marc said, anything that is dear to us, and dear to us is our underwriting capability we have as a corporation, we will protect that. Of course, we will be prudent managers and try to manage expense with that parameter. At the end of the day, if it comes to what we call muscle, which is underwriting capability and knowledge, that it might not be fully usable at this point in time, we will retain that because we make decisions for the long term, not the short term.
When things we can eliminate and they don't have a long-term or short-term effect to what we do, we'll be prudent managers and do so we can get a more reasonable expense ratio. That's our philosophy, and that's what we're going to practice as a management team.
Got it. As far as reinsurance concern is then the view there still that at this point, the changes that are taking place in the market are cyclical. You'll make that sort of bone muscle decision according to that as sort of a baseline?
Absolutely. At the end of the day, there is wonderful things you can do in a good market in reinsurance. You need to have the capability. I think we have proven that our reinsurance team is one of the best in the industry over the last 12, 13 years. All you got to do is look at their performance.
Got it. Thank you for that. If I could, just one quick one on the MI. Is it possible to break down what the underlyings were or what the loss ratio was, even on a stated basis between the MI reinsurance and the flow business, the U.S. MI business? Were they relatively similar?
We can do that. Let's see. It'll make me think, Michael.
I'm sorry.
He's going to give you specifics, but I can tell you the reinsurance business was slightly better-
Okay
than our own MI business for the simple reason, most of our reinsurance business that we wrote is in the very best years in the business. This is 2011, 2012, and 2013 commitment.
Right
Do you want to get more specific, Marc?
Yeah. I'll do more directional than order-
Fair enough
than order of magnitude. The U.S. operation continues to improve, like per our comments with the good improvement in delinquencies. The reinsurance was lower still, and a lot of that is due to a calendar quarter effect of recognizing favorable results on our reinsurance treaties issued a couple of years ago.
Got it.
You don't have gigantic earned premium numbers coming through a calendar quarter, so you make a change on a prior treaty on a inception to date basis, and it can move the numbers.
Got it. Real quick, any impact from the PMI quota share reinsurance program in 2Q results, or is that embedded in the reinsurance discussion you just gave?
There was no real impact from that.
Okay, great. Thank you so much for all the answers.
You're welcome.
Our next question will come from the line of Sarah DeWitt from J.P. Morgan. Please proceed.
Hi, good morning.
Good morning.
On the mortgage insurance business, you showed some nice growth in the quarter in terms of the U.S. risk in force. Now that you have all the key bank approvals, do you expect a positive inflection point in the risk in force in the second half of the year? Could you just talk about how we should think about the trajectory on the growth?
Well, it will be a steady improvement. Not only you have to sign up the banks, but eventually you got to make sure that from an IT point of view, all the pipes, they're open and we're starting to receive that. I wouldn't say you're going to see an abrupt change in that trajectory. As you know, with the mortgage business, every quarter adds, and we're pretty happy with the progress that our sales force is doing and also the business that we're receiving. We have received from 200 and some 70 banks applications to write the business. We're still working. We're not at optimum pace yet. I'll be happy when I'm receiving from all 700 or so. I don't know how long that will take because these projects, they get into the IT departments, and sometimes they take six weeks, sometimes they take six months.
I can't predict that.
Okay, great. Just from a high level in U.S. mortgage insurance, how are you winning? What do you view as your competitive advantage there?
Well, with one of the highest rated MI paper. From a credit point of view, we should be. We have a terrific reputation on service with everybody that we have done business so far. We're getting very good comments about our responsiveness and our service capability. The combination of those two, I think, it fares well for us for the long term.
Sarah, I would also add, we have Arch Mortgage Guaranty, which I tend to kind of phrase as like an E&S carrier for the mortgage space, that it'll do jumbo loans and other things that are non-conforming.
Right. That's an additional service we give to all these banks for loans that they might retain on their books, and they won't go to the GSEs. We have that capability with a very, and let me reemphasize, very highly rated paper.
Okay, great. If I could just get one more in. On all the consolidation we've seen in the industry, could you just talk about what the implications are of this for Arch from a competitive standpoint? What inning do you think we're in this consolidation wave?
As far your baseball question, I have no clue. I don't see how they come out of the blue, and there is a lot of dating and there is a lot of marriages and all that, but I don't know. From an effect point of view, let me give you our view. Our view is that by consolidating on the primary side, you have less buyers or more concentrated buyers of reinsurance. I think that will put some pressure, probably further pressure on the reinsurance purchasing, because the bigger the buyer, the more they buy, the more the leverage they have, and also they can use even alternative structures, as we have seen with some. On the insurance side, I view it as opportunities for the simple reason that history tells us that never in a consolidation of insurance operations, one plus one equals two plus.
It's usually one and a half to one and three quarters, and there is things that fall off the table. It could be people who want to make a change in their careers. It could be overlining of lines and depending on coverages, and the client says, "I don't want to put all my eggs in a bigger basket now." We're ready and willing, and we have instructed our underwriting units to be a participant in that activity when it occurs. Some of that will occur.
Great. Thanks for the answers.
You're welcome.
Our next question will come from the line of Charles Sebaski from BMO Capital Markets. Please proceed.
Thanks. Good morning.
Morning.
I wanted to just talk about the ROE profile on a consolidated basis for you guys, and how that plays into if more capital needs to be returned. I guess, Dinos, as you've talked about for some quarters now that the current business return profile's been in the 10%-12% range. We have a period like this, and I realize it's only basis points below that double-digit level. At the low end of that range in a period that's relatively light on cats and relatively strong on favorable development, how should we think about how you guys managed to the consolidated ROE profile and how much capital you need to hold? And whether there's capital in MI that's kind of affecting that? That would help.
Let me take you back a little bit because I think based on your question, I think you might be confusing underwriting ROE versus calendar reporting. We don't pay any attention to calendar reporting because that's an accounting. Underwriters love accountants, but they don't pay a lot of attention to it, right? The ROE that we calculate is on an underwriting basis, meaning how much capital I need to support this business, and what is the return when I write a new piece of business? That's the way we base those numbers. Prior year reserve releases or additions will not affect that, et cetera. The 10-12, we calculate based on our pricing model that comes from our pricing actuaries, the mix of business we have.
Just to give you a little flavor is that we're very happy with our insurance business, especially on the small to medium-size accounts. They're producing good ROEs. We're not so happy, but you can eliminate all of some of our larger accounts or ROEs. On the reinsurance sector, the ROEs have been very good for many years, but they're coming down as the pressure continues, including a big component of good ROE was the cat business, but that now is not producing what we traditionally expected for a high volatility line in ROEs. We're very happy with the ROEs on the mortgage insurance. We put that all in a hat, our actuaries go through that, and that's how we estimate the underwriting ROE. I'm not telling you that every single thing that we do has a double-digit ROE component.
If that was the case, we would have better than the 10 to 12. We got businesses that they're running maybe five, six, or seven, and the question is, should we get out of it or not? That's not an easy question. Usually we'll look at what the prospects are over a longer period of time, and sometimes you got to stay in those accounts and in those classes for a while at a lesser return, in order for you to be a player when things get better. That's the way we think about it. You saw underwriting ROE calculations, not calendar year ROE.
Okay. No, I appreciate. I just was thinking. I realize you guys look at it that way. I was thinking of it in the view of, if the underwriting ROE profile is 10 to 12 over a three or four-year basis, it kind of ends up mirroring up with the calendar year, no? If you're always writing 10 to 12, over time, the calendar year and the underwriting year should mirror each other, I guess. I do appreciate the color.
If it was a steady 10 to 12 for all times. I can tell you, the underwriting ROEs in the 2002, 2003, 2004, 2005 years, they were in the 20s plus. That helped us have mid-teen ROEs for some years, when actually the underwriting ROE was in the low teen. We look at it at both ways, but I can tell you, from underwriting decision making and viewing the healthiness of our business, we're religiously looking at underwriting ROE. We allocate capital to our treaties. We allocate capital to our primary business by sector, and then we have an expectation of return out of that based on our pricing, and then we calculate the ROE on that basis.
I guess just one additional and into the business. You mentioned that a couple of the programs were terminated this quarter. I'm just wondering what programs and how many programs are left and what was going on that's kind of said, was it an ROE? Was it just people? What happened? That has been one of the growth drivers for the insurance business and a couple of quarters where it's kind of slowed down a little bit. Thanks.
Well, with anything that we do, everything goes to an underwriting review once a year. I don't care if it's programs or the D&O division or the E&O division, et cetera. At that point in time, there is an actuarial indication as to what rates we're charging, what is the profitability of that book of business, and there is what we will call the rate indication. There is a discussion with our partners. Our approach with our program business is that we want to be profitable, but also we want our MGUs to be profitable. You don't have a partnership if one makes money and the other one doesn't, and vice versa. We want all of our MGAs, MGUs to be profitable, and we want ourselves to be profitable. There is that discussion. This is the market. This is what we believe we should be charging.
Sometimes there is disagreements. If the disagreement is large enough, and we don't believe we can achieve that partnership going forward that both of us will make money, we make the hard decisions, and then we decide to part companies. Unfortunately, it did happen for two of our programs that our rate indications and what we wanted to file and price that business in the marketplace was not in agreement with our partners, and they chose to go elsewhere.
Can you let us know what? Oh, yeah, please.
Yeah, Chuck, just for a little extra color. Those two programs annualized are about $45 million of gross written premium. We keep high nets on that, so it's not far from a net written premium number, firstly. Secondly, they were pretty much even in terms of they're both north of 20 or north each. One thing to keep in mind, though, is that this quarter on one of those programs is very heavy in the second quarter. It was to a tune of 50% of their total program. The loss of that program is going to be more felt in this quarter than any other quarter for the balance of the year from that program.
What kind of products were these programs? Do you have any
The S- word was one. I prefer not to really get into it.
Okay.
The underlying products themselves are really package policies.
Okay.
Yeah.
Thank you very much for the answers.
Thank you, Chuck.
Our next question will come from the line of Jay Gelb from Barclays. Please proceed.
Thank you. On the M&A front, Dinos, you were very clear about focusing on adding teams of people and renewal rights transactions, then seemingly way third down the list is acquisitions of businesses. Going back to even the recap of Arch in 2001, I don't think the company's ever issued shares for acquisitions. Is there any circumstances where you could see that occurring in the future given the massive phase of M&A in the industry?
Yes. We care a lot about our shares. It's our shareholders' value. If the transaction is large enough and our cash capability, even though there is not significant leverage on the balance sheet, we do have borrowing ability to a certain degree. Depends on how big the transaction is. We will consider issuing shares, that's the last consideration, not the first. We try with all of our decisions, not to dilute our common shareholders. We don't like a lot of dilution.
As a follow-up to that, harkening back to Dinos' comments, think of it this way, that the recoupment of any goodwill or any excess premium you'd pay relative to what we do in share buybacks. If we're looking for three-year paybacks in share buybacks where we know our operations, it's us, we know what's going on, versus something, as Dinos mentioned, with a lot more uncertainty, the three-year payback is an upper bound for a recoupment of tangible book value hit towards an acquisition. We're very mindful of that.
Okay. That's in line with what I would've thought. Marc, with regard to that buyback comment, you're in an enviable position of having a high multiple. The stock today, I think, is right around 1.5x book, I think that's starting to bump up against your tipping point on whether Arch does buybacks as opposed to special dividend. Can you give us your perspective on that?
That's exactly Dinos' comment about us being prudent in how we do it. At 1.5, I'll be honest with you, it's more of a stretch to do that unless you could find a profitable block trade or something.
Based on recent transactions, it's a cheap stock.
Agreed. Thanks very much.
I can't wait to read your report then, Jay.
Our next question will come from the line of Joshua Shanker from Deutsche Bank. Please proceed.
Yeah. I want to get you guys out to the souvlaki soon.
No. Today on the menu is moussaka.
Oh. Well, I don't know if it compete with your mother's, though, what can you do?
Well, my mother is in Cyprus, unfortunately, we got to deal with the local restaurant. Yeah.
Okay. Two questions. First of all, Michael Nannizzi asked a question about mortgage reinsurance versus mortgage primary, he said on the margin, the reinsurance was more profitable because of the good accident years. If I think about reinsurance in general, companies have been bumping up commissions, when I talk to a lot of reinsurance, they say, "Oh, our book, we use a lot of local players, we get better deals." Clearly, the large companies are going to arb you out. When it seems that mortgage insurance is so profitable these days, how is mortgage reinsurance so profitable? Why aren't the large players charging to cede that risk?
For the simple reason that when these transactions, Josh, were taken, don't forget, in the mortgage space, you make a transaction in a particular year, and you have a stream of revenue that comes over six, seven years. At the time that these transactions took place, we were providing very valuable capacity to people that they needed capacity. For that reason, I think we had equal negotiating leverage as they did. They needed our capital as much as we needed the business, that's a good combination. For that reason, we got terms that they're not disadvantageous to them, but they're not disadvantageous to us either.
Okay. Makes sense. Number two, Marc went through in detail on the expense ratio for the insurance business. Mortgage insurance has grown dramatically over the past 12 months, expense ratio really hasn't come down. When should we think that's going to occur, and why isn't that proportional with the growth rate of the new insurance written?
Well, the growth is starting to show, don't forget, also, we had an acceleration of expenses because we were building these marketing team that is out there. We added, in the last, I don't know, five quarters, some 60 people purely in the sales and marketing area. I think now we're at a steady state. When it comes to that, it's not going to be a significant additional in personnel in our mortgage business. As the volume starts going up, you're going to start seeing the reduction in the expense ratio.
One last MI question. How should I think about growth and capital? Do you need to dividend money down into Arch Mortgage US in order to fund future growth?
No. We gave you that number, Josh. I think now we're operating at around 10. 9.7, I think is the exact number.
You can go to 15 if you want to.
As I'm getting older, I don't like to be exact because I forget things. We got a lot of room to go to 15 to one. I don't see us requiring downstream capital into those operations for a couple more years. I think I use a size 3 shoe to a size 9 foot. We still got the opposite. A foot is size 3 and the shoe is size 9. We got a long way to go to fill it.
Hey, you just have to walk carefully, though.
Yeah. Well, Dinos has a nice shoehorn.
Yeah.
If you're asking more mechanically, there's money in the U.S. holding company that is there for when the need is. That's the mechanism through which they'll get it.
Yeah.
Okay. Well, thank you for all the answers, good luck in the back half.
Thank you.
Thank you.
Thank you, Josh.
Our next question will come from the line of Ryan Tunis from Credit Suisse. Please proceed.
Hey, thanks. I guess my first question is probably just for Marc. It's a quick one. Just on the E&S MI, you were talking about the jumbo loans. Is any of that showing up in the insurance and the mortgage NIW yet?
It's very, very tiny. It's really part of a value proposition that helps us. As of yet, it doesn't have any material volume.
I guess maybe looking out over the next couple of years, do you have a view on how much that type of stuff could make up of the total U.S. MI business?
No. It's a real crapshoot of what's going to happen macroeconomically.
It's very hard. The fact that we have that capability, though, it opens doors and it allows for a better conversation as to what can we do for these banks beyond that, "Oh, are you going to be cheaper than somebody else?
Okay. Then I guess for Dinos, just on expenses, I guess, in primary and reinsurance. Just trying to think about a level. Is there maybe a level of growth that you think you need in the medium term to support your current expense growth profile? It doesn't seem like-
No, we never really run the company in any segment, with the exception of MI, because we think it's a very good time to grow on a growth prospect. Having said that, you got to match revenue with expense as long as you don't cut muscle. I will accept one or two points higher expense ratio than normal as long as I'm not losing underwriting capability, because that underwriting capability can produce what it will cost you to maintain for a year or two or three in one quarter. Let me remind you guys, in the 2002 year, our reinsurance operations produced, on an underwriting basis, $790 million worth of premium, and we had 22 people. Right? It can come, and I can tell you, the profit coming out of that, it was significant.
At the end of the day, it's that balance, and you got to make those hard judgments. I can tell you, if I got good, experienced underwriters, they don't have to worry about their jobs as long as with us. We'll find things for them to do, and if they don't, we'll have to ask them to play golf until the good market comes.
Got it. Thanks, guys.
Our next question will come from the line of Meyer Shields from KBW. Please proceed.
Okay, thanks. Marc, you mentioned that you can't necessarily infer anything strategic from the shortening of the portfolio duration. Can I put that as a more direct question? It also could reflect something. Is there anything that we should read from the second quarter change?
No, let me expand on it a bit. It is a point in time estimate as I mentioned. We continue to have the same exact process where we look at the liability stream and we duration match it. However, the assets underlying shareholders' equity are shorter. There's no fundamental change to the overall philosophy and the overall approach of matching loss reserve duration, which I think is the most important thing. There's going to be tactical moves that happen from quarter to quarter. I wouldn't look for some big theme.
Okay, that's helpful. Just a quick numbers question. We look at the other expenses, and I mean this on a consolidated basis, came in at $17.4 million, up almost 17% year-over-year. Was there anything unusual there or is that new good run rate?
Well, let's see. You have a slight increase in overall stock-related compensation expense for old dogs like me, that are retirement eligible. There's a different accounting treatment of quicker recognition of those kinds of things. It's a series of a bunch of tiny things. It's not that I can asterisk for you if that's a main driver.
Okay, thanks so much.
Our next question will come from Brian Meredith from UBS. Please proceed.
Yeah, thanks. A couple questions here for you. First, Marc, when you talked about rate on the portfolio, the minus 0.8%, you said that's net of reinsurance. What does it look like on a gross basis before reinsurance? I'm wondering-
Yeah
the advantages you're getting and how that's looked over the last maybe year or two, so we can get a sense.
Yeah, it's a little worse, it's converging now because it was really the benefit of property cat, really, and some other that really drove the differential. Without getting into exact numbers, it's a little bit worse on a growth basis. That's exactly why you protect yourself with effective reinsurance.
Got you. The second question, looking at Watford Re, I'm just curious, obviously a lot of growth there on a year-over-year basis, relatively new. Are we getting to a point in the marketplace where even Watford's going to potentially have to pull back a little bit given the great competition out there?
Well, it will depend. It's the same underwriting process that we have for everything else we do. The only difference between what Watford will do versus what Arch will do is we believe that their ability as they take a little more risk on the investment side to produce a higher return on the investment gets factored in. They're turning down business too. Without having something in front of me, an account to go through, it's very hard to predict as to That's why we never predict volumes, because the market can be very fickle. It can turn on a dime either way. It can get much worse quickly, and it can get much better quickly, depending on what happens. Our projection is that it's probably is getting worse before it will get better.
For that reason, we're very careful in our underwriting processes. We don't have these kind of failures that we get too optimistic on the basis that things will change quickly. Then we can make it up in the future. We try to write accounts that, in our view, will produce an adequate return. That's why you saw our volume going down a bit.
Right. Is there any business that you perhaps would have kept on Arch's balance sheet last year that now all of a sudden is going to Watford's balance sheet because of what's going on with rates? Are we seeing that?
Yeah, there is some of that. Yes, absolutely. That was the purpose of us creating Watford. Instead of throwing that business totally out, at least it can go to a place that we get a participation. We have an investment in it. It keeps us aligned in that. Also, we can benefit on sharing some of the cost because if you discard the business, you have no revenue at all, where if you're writing it, you're getting reimbursed for the cost of writing it. Then potentially you have also the profit sharing in the back end. Yes, there is some of that business that otherwise would have been lost by us that has gone to Watford, yes.
Be cognizant, Brian, that remember, Watford has its own management team. They have the ability on yay and nay on contracts. Let's roll forward a year. It's possible Watford, forget Arch and Watford. Watford itself may decide to not renew something that they found in a prior year because of ongoing rate suppression or yields not being realized or something of that nature. It's not just an Arch sense. It's completely a Watford sense and their evaluation.
Great. Thank you.
You're welcome.
Our next question will come from the line of Jay Cohen from Bank of America. Please proceed.
Yes, thank you. Most of my questions were answered. Just, I guess one question on the mortgage segment. The accident year loss ratio jumps around quite a bit quarter to quarter to quarter. It's relatively new business, I understand that. At some point, should we expect that number to kind of settle down into a more narrow range going forward?
Hey, Jay, good question. The answer is accident year in mortgage business doesn't make much sense. After all, it's a function of the delinquencies and then claims emanating from the delinquencies. Until there's a claim, you can't put a reserve up on it yet. You can't anticipate performing loans becoming non-performing and having claims emanate from it. We've railed against the accounting proceeds, statutory accounting in that business. It's going to jump around.
I will focus more on the delinquencies. It's a better measure than anything else.
Got it. That's helpful. Thanks.
Our next question will come from the line of Ian Gutterman from Balyasny. Please proceed.
Hi. Good afternoon to you, guys. I actually was going to ask something similar to Jay, just to follow that up. Marc, can you just walk through a little bit, you mentioned it was mostly the reinsurance loss ratio that came in lower, and it sounded like there were some contracts that were reviewed, I guess. Can you sort of walk through that process? Is that sort of an annual review, or was it just you got new information in the quarter and you reflected that? Or sort of what led you to make that revision now?
Sure. Yeah, Ian, it's no different than any sector of our business. There's reserve reviews by the business unit actuaries that occur every quarter. It just happened that those particular treaties had enough information and forward viewpoints that it was going to develop more favorably, and it was recognized so.
It's the reporting from the clients. When they're showing significant improvement, you can't ignore it. They have shown significant improvement.
Just like the PC reinsurance side, it's completely analogous.
Well, that's why I was wondering, was it reports from the client? It is a little bit different market.
It was from the client showing-
Got it.
significant improvement. Yes.
It wasn't that you guys went in and looked at the contracts on your own and decided to lower the roll rate or something like that. It was that the incoming information was significantly better and that you had to adjust to that.
Yes. Pleasant surprise for both them and us.
Perfect. Do you get that information from them quarterly or is that kind of a once a year thing or?
Quarterly.
Quarterly. Okay. I just want to make sure there wasn't a seasonal nature to this is what I was after.
No.
Got it. Okay. Just on M&A, one of the things that gets speculated upon is the ability for you or some others on the island to help sponsor an inversion of someone who wants to get offshore. Just is that a meaningful rationale to do a deal that meets your criteria on other metrics but maybe not as strongly as another deal that was better strategically and so forth and didn't have an angle to it, I have a follow-up on that.
Like I said, price and financial is the fourth item.
Got it.
If the first three meet criteria, we'll get into the fourth. By the way, our view is both in us purchasing something or somebody purchasing us because unless you're my wife who says the house is never for sale, at the right price, the house is for sale. I'll sell my house if somebody gives me the right price. No emotion here. Our view is we are employed by the shareholders to do the best job for our shareholders, there is nothing more to think about other than that.
Got it. Specifically just to follow up on the inversion specifically, I don't know how closely you guys have followed this, but I guess my understanding is that when Treasury made those changes last year, that if a company like Arch were to buy a company in the United States and invert them, that depending on how it was structured, there's a chance Arch could lose its tax status. Is that your understanding that essentially inversions are kind of on hold until Treasury clarifies that language?
I have no idea because we haven't studied that.
Okay
I don't have any more insight to it. It's highly a legal question and a structure question if you want more, I'll do some research on it and offline we'll share our thoughts with you. It hasn't come across my desk as a situation that I have to focus on.
Yeah. That topic, we've really just focused on the fact that we recapitalized back in 2001, all legislation and all proposals really had a grandfather clause.
Right
I know you're asking a forward view, our look and evaluation of that has been the preservation of what we have.
Yeah. Obviously, if you want to do a transaction, there's no issue. I guess there was some language I read about, I can follow up with Don offline, that if you were to buy something, it could affect the status possibly. I don't know if that was a hang-up. That's all I was wondering, I'll follow up with Don.
Well, if it does, it's part of the mix, right? You think I will do something stupid for my shareholders?
No, of course not. Just seeing if I was reading the language right. If you're not familiar, we can follow up offline.
Yeah. The salt and pepper my mother uses has no stupidity in it.
All right, very good. I'll let you get to your lunch since you can have your salt and pepper with your moussaka. Bye.
All right. Yeah.
Our final question will come from the line of Kai Pan from Morgan Stanley.
Thank you. Sorry for keeping you guys on. I'm really at a backup.
Not a problem, Kai. Take all the time you want.
Yeah. First question on the underwriting margin going forward, it looks like the last price spot on long tail casualty primary business, the pricing now below the cost trend. Are we expecting, on the written basis, the underwriting margin will deteriorate? Anything in your power you can alleviate that or control that deteriorate?
Yeah. The answer is yes to both of those. We always talk about the mix of business. These guys are active cycle managers, whether it's within reinsurance or within insurance. Where you see it going negative, you can either attempt to drop some of your front-end volume or perhaps could, as Dino talked about earlier, the reinsurance market is in a place where you can get attractive terms and could get some benefit on that on a net basis. The insurance group will be looking for that change in mix front end and change of reinsurance to ameliorate some of that. Mix alone could change that, Kai. On the written basis in a quarter or two from now, even with no changes in reinsurance ceded programs by the cycle managers, that one could be a plus two or plus two and a half.
Okay. On the reinsurance side, looks like this quarter is actually the accident year loss ratio, ex cat improved a little year-over-year. Is it just because of lower level of losses or anything there?
Well, that was the insurance comment. The insurance comment, when you control for the larger attritionals, was really the same loss ratio second quarter, accident quarter, second quarter last year to second quarter this year. The reinsurance group, it did go up a bit, but that's a function of the mix of business because we're not writing the property cat. We're near to the levels we used to in the past, which has a much lower expected loss ratio.
Okay. That's great. Last question on the recently proposed IRS rules on PFIC. I just wonder if any comments, what do you think about Watford's status on that?
Like I said, Watford is an active insurer which it assumes a tremendous amount of reinsurance. The proposed rules are a work in progress, so we don't know the final rules. We will continue to monitor that process, and we don't believe there is a problem for us complying with whatever rules they come up because let's go back to the first thing. Watford is an active insurer that assumes a significant amount of reinsurance, and it has significant amount of reserves.
Great. Well, thank you so much for that, and thanks for this.
Thank you.
You are welcome.
I would now like to turn the call back over to Dinos for closing remarks.
Well, thank you all. We're looking forward to talking to you next quarter. It's time for lunch.
Ladies and gentlemen, you may now disconnect. Have a great day.