Mount Logan Capital Inc. (MLCI) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Mount Logan Capital's Fourth Quarter and Year-End 2020 Results Conference Call. Please note, this event is being recorded. Before we begin, I would like to remind listeners that except for historical information, the matters discussed during this call may include forward-looking statements within the meaning of the applicable Canadian securities legislation. Forward-looking statements involve known and unknown risks and uncertainties and other factors that may cause actual financial results, performance or achievements to be materially different from estimated future results, performance or achievements expressed or implied by those forward-looking statements. All forward-looking statements reflect the company's current views with respect to future events and are subject to risks and uncertainties and assumptions we have made in drawing the conclusions included in such forward-looking statements. The company is not obligated to update or revise any forward-looking statements, and we do not assume any obligation to do so. For a description of the risks associated with the Mount Logan Capital's business as well as information about the material factors and assumptions that could cause results to differ from any forward-looking statements and other relevant factors, please refer to the company's public disclosure record, particularly the company's MD&A and annual information form for the year ended December 31, 2020, which are available on SEDAR. I would now like to introduce your host for today's conference, Mr. Ted Goldthorpe, Chief Executive Officer of Mount Logan Capital. Mr. Goldthorpe, you may begin.

Thank you. Good morning, everyone, and thank you for joining us for our fiscal year 2020 results call. During the call, we'll be referring to information provided in the financial statements, the MD&A and the associated news release for the year, all of which were released yesterday and are available on our website and on SEDAR. Joining me this morning is our Chief Financial Officer, Jason Roos; and our Co-Presidents, Matthias Ederer and Henry Wang. Overall, we are pleased to announce that Mount Logan had another successful year. Our portfolio performed remarkably well over the course of the year in the face of significant turmoil, and we successfully executed on a number of strategic transactions to accelerate Mount Logan's transition to an asset management platform. Before we speak to our financial results for the year, I will highlight our fourth quarter activities, which include a number of acquisitions, the closing of our equity raise and will provide some brief remarks on general market conditions and outlook. We had a tremendously active fourth quarter on the strategic transaction front, and I'll provide an update on each transaction separately. On the capital raise side, we closed 2 tranches of our private placement in October and November, raising CAD 17.5 million at a share price of CAD 2.75 per share. Aided by Canaccord Genuity, ATB Capital Markets and Stifel GMP, we are pleased to welcome new major shareholders to Mount Logan in addition to incremental participation from existing key shareholders and from the directors and officers of Mount Logan. The net proceeds of the capital raise were primarily used to fund our transaction with the interval fund known as the alternative Credited Income Fund, or CIF. We closed this transaction at the end of October of 2020, following a successful vote by the underlying shareholders of CIF. As a reminder, CIF is a U.S.-based continuously offered closed-end quasi permanent capital vehicle that invests in credit assets that are highly complementary with Mount Logan's mandate, including direct lending, private credit and public credit. Upon funding approximately $12 million at close, Mount Logan is entitled to the net economic benefits associated with the management contract for CIF, a fund that has a 1.85% annual base management fee on approximately $260 million of fund assets as of year-end. Performance of CIF since closing has been strong. And through the end of February, the fund has achieved an 8.2% return since inception in 2015. Based on the continued attractive risk-adjusted performance of CIF, we look forward to continued growth of the fund in the coming quarters. In November, we closed our transaction with Garrison Investment Management, whereby Mount Logan acquired the management contracts for a CLO platform with over $650 million of assets under management. CLOs, or collateralized loan obligations, our portfolio is of first-lien senior secured loans that are securitized in the debt and equity-like tranches. We find the CLO asset class attractive due to its long duration, low volatility and skew towards first-lien debt and general growth trajectories as CLOs continue to be a larger part of the global debt markets each year. Since taken over the investment advisory role of the 2 ramped middle market CLOs, we've actively leveraged our team's sourcing and underwriting capabilities to optimize the asset base of the CLOs, reposition the portfolios and rotate into higher quality loans without sacrificing yield. Gaining a CLO platform dramatically increases our AUM and is deeply aligned with our goal of transitioning from generating asset-intensive interest income to consistent management fee streams. In connection with the CLO transaction, Mount Logan's wholly owned subsidiary, Mount Logan management applied for and received approval from the U.S. SEC to act as a registered investment adviser. So far, Mount Logan management serves as the advisers to the CLO-related funds, but the adviser status paves the way for us to manage assets for U.S. clients across other fund products, and we expect to leverage this advisory status in future strategic transactions. In December, we announced that Mount Logan completed the acquisition of a 21.4% equity stake in Sierra Crest Investment Management for $7 million. Sierra Crest is a registered investment adviser in the U.S., whose primary activity is the management of Portman Ridge Financial Corporation, a growing publicly traded business development company, or BDC, with $600 million of assets as of year-end. We are favorably inclined towards the BDCs as they are permanent capital vehicles, have a highly diversified exposure to credit and are compelling fund type for both investors and managers. Most notably, this acquisition was structured with no upfront cash payment and was financed with $5.3 million of debt, which results in a very strong cash and cash return that will continue to improve alongside Portman Ridge's growth. Later in December, Portman Ridge announced its intention to merge with Harvest Credit Capital Corporation, a U.S.-based closed-end externally managed BDC that provides customized financing to small and midsized businesses across North America. The Harvest Capital transaction represents the third M&A transaction completed by Portman Ridge since coming under the management of Sierra Crest in April of 2019. Over 2020, Portman Ridge nearly doubled its total assets through organic and acquisitive growth as Mount Logan now owns 21.4% stake of Sierra Crest, the increased scale of Portman Ridge, which will result in a larger base of fee-generating permanent capital that will flow to Mount Logan. Across CIF, the CLO platform and our minority stake and Sierra Crest, these are a few of the different ways Mount Logan is transitioning into asset management and diversifying its business while staying true to its core competency of credit assets in North America. As part of the funding of the above acquisitions, we've been actively managing our portfolio to provide interim interest income generation until capital needs arise with any new transactions. At year-end, we sold approximately $15.9 million of illiquid loans in our investment portfolio at a weighted average price of $98, which was above the weighted average fair market value of the respective loans as of prior quarter's end. This material divestiture and respective sale prices serve as a testament to the quality of our portfolio and the rigor of our ongoing quarterly valuation product approach. In connection with the sale of a portion of our investment portfolio, on February 4, 2021, Mount Logan terminated its revolving $50 million leverage facility and repaid the $34.4 million outstanding balance. Our leverage facility and lending partner were integral in enhancing our portfolio yields during the first phase of Mount Logan's business plans. However, given the asset-based nature of the facility, the cost and lack of flexibility meant that it did not make sense to maintain the facility among -- amid Mount Logan's accelerated transition to an asset management-oriented business model. Given attractive financing terms available in the general market, we have used and will continue using prudent amounts of debt to finance asset management transactions in the future. We view the aforementioned transactions as significant progress towards the market ascribing value to the management fee streams associated with our business, and thus transitioning to being valued similarly to our asset manager peers as opposed to being valuated on a price-to-book basis. While this is our first quarter of generating management fee income, the full extent of the fee generation potential will begin to flow through in the first quarter of 2021. Furthermore, we believe there is an extraordinary market opportunity right now and could be continued to actively assess new strategic management transactions. As of year-end, our core investment portfolio of $21.8 million entirely consisted of first-lien senior secured term loans. Our promissory notes and equity investments totaling $19.5 million are related to our transaction with CIF and our minority stake in Sierra Crest, respectively. Looking at our portfolio today, we continue to assess reducing the size of our investment portfolio, and we'll continue to balance interest income generation while divesting or contributing our portfolio assets opportunistically to support transactions that fulfill our goal of generating recurring asset management fee streams. Turning briefly to current market conditions. As many on this call know, market conditions greatly improved over the course of 2021, following the correction of March of 2020. In the fourth quarter, credit spreads tightened to nearly pre-COVID levels, which has remained unchanged. Looking ahead to the end of the first quarter of 2021, which will conclude next week, given current market conditions, we expect that our portfolio and the portfolios we manage will continue to exhibit stable performance. Our portfolio has no direct exposures to the COVID-19 affected sectors, and we are very discerning on underwriting new investments that have been impacted by COVID-19. In terms of dividends in 2020, we paid CAD 0.02 per share each quarter, resulting in CAD 0.08 per share paid for the year. We are maintaining our dividend for the quarter, and we'll be paying CAD 0.02 per share for shareholders as of record on March 31. Before we review our financial performance, I would also like to take the opportunity to provide a brief introduction of our newly appointed Chief Financial Officer, Jason Roos. Jason joins us after nearly 20 years of experience in financial leadership positions, including roles at Wells Fargo and PwC. Jason brings to Mount Logan a wealth of technical and controllership expertise that help us drive the process needs within Mount Logan as we continue to grow. We are fortunate to have someone with Jason's experience and background joining our team.

Thanks, Ted. Good morning, everyone. And first of all, I want to say it's a pleasure to join the management team at Mount Logan. And I'm excited to serve as the Chief Financial Officer, especially during such a transformational time in the company's development. I'll now summarize the key highlights for the 2020 fiscal year and the fourth quarter of 2020. As a reminder, all figures I reference today on this call will be in U.S. dollars, Mount Logan's functional and presentation currency. For the year ended December 31, 2020, we generated $3.9 million of total revenue, an increase of 12% year-over-year. Fourth quarter revenue was aligned with income generation from the prior quarter. But most notably, this was the first quarter of management fee generation, which we expect to continue to ramp over the course of 2021. On the expense side, for the year ended 2020, we incurred $765,000 in transaction costs and $874,000 in professional fees related to legal, audit and tax consulting. These expense line items were heavily concentrated in the fourth quarter in connection with acquisition activity. Other costs, including directors' fees, marketing, regulatory and shareholder relations as well as other general and administrative costs totaled $1.5 million for the year and $523,000 for the fourth quarter. Utilizing our leverage facility, Mount Logan incurred $2 million in interest and credit facility expenses as a result of drawings under the loan facility. As our $50 million leverage facility was terminated and repaid in February, interest expense is expected to be significantly lower going forward. In the fourth quarter, we increased the valuation allowance against our deferred tax asset, which resulted in a noncash deferred tax expense of $1.1 million. This is a result of the reduced likelihood of realizing the benefits of such deferred tax assets going to shift in cross-border business activities in Mount Logan. In the year, we faced a net realized gain on investments of $87,000, which was partially outweighed by a small realized loss in foreign currency of approximately $56,000. We had unrealized depreciation on our investment portfolio of $477,000. However, this marks a steep rebound in the value of the investment portfolio from the $2.3 million unrealized loss that was experienced in the first quarter of 2020. This rebound in valuation is a function of the continued recovery of credit market condition since the market volatility experienced earlier this year in light of the COVID-19 pandemic. Our total and comprehensive loss was approximately $1.8 million for the quarter or $0.12 per weighted average share. To frame the context around earnings this quarter, Mount Logan is in a transitionary period before its business model, having begun to divest the number of on-balance sheet loans in the portfolio and pursuing strategic acquisitions and asset management, a number of which occurred in the midst of the fourth quarter. Accordingly, the financial statements reflect these activities and transaction-related costs, which have been incurred in Q4, whereby the sustainable cash earnings potential business is expected to grow in future quarters, evidenced by a partial quarter of management fees earned. Mount Logan incurred a number of nonrecurring or noncash items inclusive of onetime transaction-related costs, the noncash by recurring amortization of intangible assets, elevated professional fees, interest on the debt facility that has since been repaid and the noncash deferred tax expense. We look to provide a more meaningful representation of our earnings power as our business continues to evolve into a diversified asset management platform. As of December 31, 2020, Mount Logan's balance sheet reflects total assets of $91 million, total liabilities of $47.8 million and shareholders' equity of $43.2 million. While shareholders' equity increased 26% year-over-year, the decline in net asset value per share was primarily attributable to our private placement in the fourth quarter, the accounting-driven noncash write-down of our deferred tax asset and other transaction costs mentioned earlier. Our asset balance at quarter end primarily consisted of $38.2 million in our investment portfolio; our $24.3 million balance in cash and restricted cash; $15.8 million in investment receivables related to the sale of portfolio investments that were in the settlement process; the $7 million investment in associates, which reflects our minority equity stake in Sierra Crest; and our $3.5 million in intangible assets associated with the management contracts for our CLOs. At year-end, our liabilities predominantly included our revolving leverage facility with an outstanding balance of $34.4 million and our $5.3 million of debt incurred in relation to our acquisition of a minority stake in Sierra Crest. As discussed earlier, we terminated our $50 million revolving leverage facility and repaid the $34.4 million balance in February. Lastly, when notable liability is the client investment associated with the contingent valuation rights, or CVRs. As a reminder, on Cline, this is an investment in equity and debt that remains from Marret Resource Corp. prior to the plan of arrangement. On October 27, 2020, Marret Asset Management announced that the Cline transaction was completed, whereby Allegiance Coal acquired all of the shares of New Elk Coal Company, which holds all the mining assets of Cline. Allegiance Coal's consideration to purchase Cline was comprised of cash, shares and debt, and it is Marret's intention that direct clients remit the net proceeds from the transaction to Mount Logan and the other senior bondholders as soon as practical after receipt, less a prudent provision for any ongoing minimal client operating costs. Mount Logan received its first small cash distribution in February 2021, and we are currently evaluating the potential for a distribution net proceeds in accordance with the terms of the indenture governing CVRs. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thanks, Jason. In closing, I want to state again how pleased we are with the progress we have made at Mount Logan over the last year. We've closed a number of accretive asset management-related transactions in the fourth quarter that have brought significant changes to the financials of Mount Logan. However, these transactions will begin to fully contribute to Mount Logan's results in the first quarter of 2021 and beyond. We are firmly committed to continuing the momentum of transitioning Mount Logan to a diversified asset management platform, and we continue to develop a strong pipeline of actionable opportunities that we have the potential to be highly transformative from Mount Logan. While market conditions have stabilized, we will continue to remain vigilant in our underwriting, monitoring and capital allocation approach, both for our own portfolio and for the new portfolios we manage as an investment adviser. It was a true pleasure to meet with new and existing investors as part of our equity raise last year, and we're planning to virtually meet with more investors to get Mount Logan's story out in the coming months. We'll now transition the call to Q&A., if the operator, please, coordinate.

[Operator Instructions] The first question comes from Pratik Agarwal with Canaccord Genuity.

I have a couple of questions. So first one is on year-to-date balance sheet investments. Did Mount Logan like dispose any year-to-date that kind of helped you pay down the $34 million credit facility and if there is any near-term M&A opportunity?

Okay. So Jason, do you want to take that first part, and I'll take the second part?

Yes, sure. So yes, so we did sell quite a few positions in the fourth quarter, which put our cash position at a point where we're able to settle out of our debt facility in Q1 here.

Yes. And on the M&A pipeline side, we continue to see a very robust M&A pipeline. So we hope to announce a couple of transactions over the course of the year, which we think will be very material and growing and enhancing shareholder value, all in areas that are consistent with our strategy and what we've talked about previously.

Okay. Got it. And then a quick question on the $13 million new investments made during the quarter. Like is there anything to highlight on this, like whether they were first-lien loans or which industry they pertain to? And then your overall view on the current credit environment. I guess you already touched upon that a bit.

Yes. So if you think about what we're doing on our balance sheet, we've effectively liquidated all of our illiquid -- most of our illiquid assets. So we're down to sub-10% of our total assets or illiquid investments. And we've replaced them with both cash and liquid investments to obviously pay off the credit facility, as Jason referred to earlier, but also to -- as a placeholder until we close some of our pipeline of M&A. That's kind of how we think about our balance sheet today. So we're in very, very safe liquid loans. In terms of the credit environment, the economy is doing much better than, quite frankly, we even expected. Our portfolio companies are doing very, very well. This latest round of stimulus, we expect to continue to benefit the economy. That being said, we continue to be very cautious. I mean the outlook over the next 12 to 18 months could go many different directions. So we really want to take our balance sheet and own permanent capital or semi-permanent capital vehicles. So if you think about everything we bought so far, they all have -- all of our liabilities are quasi permanent, which means that we can withstand various cycles without being forced sellers, and we can generate consistent fee streams. So I think we're seeing really good performance in our underlying companies. Obviously, credit markets are very, very tight right now in terms of spreads, but we remain very, very vigilant and cautious about the environment over the next 12 to 18 months.

[Operator Instructions] The next question comes from Charles Burns with CIBC Wood Gundy.

You guys did a good job of navigating last year's tough environment. I guess, I go back to the shareholder from the predecessor company, and I guess, I see the shareholders' equity increased year-over-year. But then when I look at net asset value, at December 31, 2019, it was $3.23; as at September 30, it was $3.08; and as at December 31 of this year, it was $2.55. Now I understand some of the things were accounting charges, et cetera. But it's a bit frustrating because, I guess, I had conversations in the past hoping -- and part of it had to do with share issuance as well as $2.75. But part of my frustration was the gap in trading price versus net asset value. And I guess, I was hoping that, that gap wouldn't be narrowed by a decline in net asset value, but that's kind of what has occurred for the time being. And I'm just trying to understand going forward of how -- and I know you want to kind of change the dynamics in terms of how the company is evaluated, but the valuation of the share price is kind of -- it seems to be more reflective of the net asset value for the time being. Can you comment on that?

Yes. I mean, you're asking a very good question. So if you think about the second half of last year, it was really a year of investment. So obviously, there's a reversal of the deferred tax asset, which is noncash, but there's also -- these transactions, we incurred a number of transaction costs. So we expect -- it's exactly what you said. I mean we expect towards the second half of this year to be generating double-digit ROEs and significant EPS growth, which obviously will build NAV over time. I mean, we really like to transition the market to looking at earnings versus book. We still trade below book. And to your point, we would like to -- we would have loved our stock price to trade higher as opposed to book value go lower. But I think it was important -- we think the share issuance, which led to some of the dilution, will prove to be worthy over time as the earnings power of the underlying businesses we bought come through. So it's going to take 1 or 2 quarters for you to -- like you'll see a material increase in fee-related earnings in the first quarter, and I think you're going to continue to see that grow over the course of the year. And that should all accrete into book value. But again, we would hope the market would look at earnings -- other metrics, such as earnings and our ROEs. But yes, I mean, all fair points. We made the conscious decision as a management team and as a Board to invest in our business in the fourth quarter, and that obviously had a short-term impact on our net asset value per share.