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 First Quarter 2021 Results Conference Call. [Operator Instructions] Please note this event is being recorded. Before we begin, I would like to remind listeners that except for historical information, 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 those 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 obliged 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 Mount Logan Capital's business as well as information about the material factors and assumptions that could cause the 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 you to your host for today's conference, Mr. Ted Goldthorpe, Chairman and Executive -- Chief Executive Officer of Mount Logan Capital. Mr. Goldthorpe, you may begin.

Thank you. Good morning, everyone, and thank you for joining us on our first quarter 2021 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 quarter. All of which were released yesterday and are available on our website and on SEDAR. Joining me this morning is our executive team, including 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 quarter, most notably with record revenue and significant growth in fees attributable to our newer asset management activities. Before we speak to our financial results for the quarter, I will provide an overview of our transaction with Capitala, the closing of our warehouse leverage facility, highlight our year-to-date progress and provide some brief remarks on the general market conditions and outlook. First of it -- of which, I will speak to our proposed transaction with Capitala. On April 21, we announced that we entered into a definitive agreement or our wholly owned subsidiary -- U.S. subsidiary, Mount Logan Management, would become the investment adviser of Capitala Finance Corp. or Capitala, as I will refer to in these remarks. Listed as CPTA on the NASDAQ, Capitala is a publicly traded business development company, or BDC, with approximately $320 million of assets as of March 31, 2021. After running a fulsome adviser search process, the Board of Capitala unanimously selected Mount Logan as its new investment adviser due to our enhanced sourcing capabilities, focused liability management, integration with our operational and support teams and expertise in portfolio repositioning. By taking over the management contract for Capitala, Mount Logan management would be entitled to a 1.75% base annual management fee on their assets under management as well as incentive fees tied to performance. This transaction significantly expands Mount Logan's asset management revenue, which would be underpinned by a permanent capital vehicle and acts as a potential growth platform for future opportunistic BDC transactions. From a timing standpoint, a special meeting of the shareholders of Capitala is scheduled for May 27, 2021, and subject to approval, the transaction is expected to close in the summer of 2021. So far, over 20% of Capitala's outstanding shares have indicated support for the proposed transaction. Overall, we are very excited about the transaction from Mount Logan and Capitala shareholders, who will receive the benefit from a larger mix of income-generating assets, lower financing costs and a management team with a demonstrated track record of consolidation in the BDC space. Last Friday, we announced the closing of a new debt warehouse facility. This $60 million facility will be used in connection with the transaction to refinance one of our collateralized loan obligations, or CLOs. The facility is intended to be short-term in nature, and we will effectively use it to ramp a portfolio of loans alongside some of our balance sheet investments, which will then contribute to one of our CLOs alongside of refinancing. We expect to terminate this facility in the summer of 2021, alongside resetting our 2018 CLO, which if successful, will increase the duration of our asset management fees tied to this vehicle. Since taking over management of the CLOs last year, we've actively leveraged our team's sourcing and underwriting capabilities to optimize the asset base of the CLOs, reposition the portfolio and rotate into higher-quality loans without sacrificing yields. Moving on to Sierra Crest. Through a minority interest, we received a portion of the economics connected with the advisory contract for Portman Ridge, a publicly traded BDC with over $550 million of assets as of March 31, 2021. Portman Ridge continues to scale with its net NAV organically increasing 1.4% quarter-over-quarter and through its previously announced merger with Harvest Capital Credit Corporation, which is on track for an expected closing in June. As Mount Logan owns 21.4% stake of Sierra Crest, the increased scale of Portman Ridge will result in a larger base of fee-generating permanent capital, which will flow to Mount Logan. Thus far, the performance of this investment has exceeded our underwriting case, and we continue to be pleased with the performance. In relation to our interval fund, known as the alternative credit income fund, or CIF, the fund had over $260 million of assets as of March 31, 2021, and performance has been strong with year-to-date returns approaching 8%. Since we closed the CIF transaction, fees and operating income have exceeded our internal forecasts. We intend to invest in this platform over the course of the year by adding additional salespeople to sell the product. We continue to reposition the portfolio by leveraging our sourcing capabilities and are actively assessing investments to support its long-term growth. Based on the continued attractive risk-adjusted performance of CIF, we look forward to the continued growth of the fund in the coming years. The first quarter marked our second quarter of generating management fee income, and we expect the full extent of fee generation potential will continue to ramp over the course of the year as some legacy onetime costs continue to flow through the first quarter of 2021. Furthermore, we believe there's an extraordinary market opportunity right now, and we continue to actively assess new strategic asset management transactions. As of quarter end, our core investment portfolio of $20 million -- $20.3 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 a minority stake in Sierra Crest, respectively. Looking at our portfolio today, we continue to assess reducing the size of our investment portfolio, and we continue to balance interest income generation while divesting or contributing our balance -- our portfolio assets opportunistically to support transactions that fulfill our goal of generating recurring asset management fee streams. Turning briefly to current market conditions. Our primary market was very strong, starting at the end of last year, and the momentum has really continued into the first quarter of this year. Given the backdrop of low interest rates, vaccine distribution-led reopenings and ongoing fiscal stimulus, the overall credit market has remained very active. Market-wide transaction volume was strong in the quarter, including both new investment opportunities through M&A activity as well as refinancing activity. Credit spreads remain wider in the direct loan origination market relative to liquid credit market. And our ability to use the breadth of our platform to source transactions should generate consistent, attractive risk-adjusted returns in excess of the broader market, aiding our efforts to reposition the CLOs and other pools of capital we now manage. Lastly, we are maintaining our dividend for the quarter, and we'll be paying CAD 0.02 per share for shareholders of record as of May 27. With that, I will turn the call over to Jason Roos, who will review the financial results for the quarter.

Thanks, Ted. Good morning, everyone. I'll now summarize our key highlights for the first quarter of 2021. 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 quarter ended March 31, 2021, we generated $1.3 million of total revenue, an increase of 41% quarter-over-quarter. This quarter marks an increased contribution of revenue attributable to our asset management activities. Our management fees related to our CLOs was approximately $0.5 million for the quarter. For the net earnings attributable to the alternative credit income fund, or CIF, this is captured in a servicing fee also reflected in management fees and an additional $247,000 in interest income. On the expense side of the -- on the expense side for the quarter ended March 31, we incurred $380,000 in transaction costs and professional fees, a reduction of 65% quarter-over-quarter as a result of the elevated acquisition activity in the fourth quarter of 2020. Other operating costs, including directors fees, compensation, marketing, regulatory and shareholder relations and other general and administrative costs, totaled $443,000 for the quarter, aligned with our previous quarter. In the first 3 months of the year, Mount Logan paid $315,000 in interest and other credit facility expenses, which is mainly in connection with our previous $50 million leverage facility that we repaid and terminated in February 2021. We incurred $190,000 in noncash amortization expenses related to the management contract for our CLOs, which is treated as an intangible asset on our balance sheet. Following the reduction in our deferred tax asset last quarter, there was no further change to the balance of our deferred tax asset this quarter. In the quarter, we recognized a net realized gain on investments of $158,000 and net unrealized appreciation on investments of $170,000 amid continued strong performance in the broader credit market. Our total and comprehensive income was $269,000 for the quarter or $0.02 per weighted average share. As of March 31, 2021, Mount Logan's balance sheet reflected total assets of $56 million, total liabilities of $12.9 million and shareholders' equity of $43.2 million. While shareholders' equity and net asset value per share remained steady quarter-over-quarter, our assets and liabilities were both reduced by $35 million in connection with the repayment and termination of our leverage facility. Our asset balance at quarter end primarily consisted of $36.4 million in our investment portfolio; our $6.8 million balance in cash and restricted cash; our $6.9 million investment in associates, which reflects our minority equity stake in Sierra Crest; and our $3.3 million in intangible assets associated with the management contracts for our CLOs. At quarter end, our liabilities predominantly included 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. As Ted mentioned earlier, Mount Logan entered into a $60 million revolving warehouse facility at the end of last week. This warehouse facility is intended to be temporary in nature, and we expect to terminate it in the summer of 2021 following the use of the net proceeds of the facility to ramp a portfolio of loans in connection with the transaction to refinance one of our CLOs. Lastly, one notable liability is the client investment associated with contingent value 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. Following the sale of Cline's principal asset in the fourth quarter of last year, we received our first distribution in the first quarter of 2021. We have been working with the right agent on coordinating our first distribution, which we expect notices to be sent out before month end and a payment date set for June 9. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thank you. We would now like to open it up for questions.

[Operator Instructions] The first question today will come from Scott Chan with Canaccord Genuity.

Ted, you kind of talked about, obviously, deleveraging the balance sheet. But I noticed that you made several investments in Q1. Was that more opportunistic with the private credit market?

Yes, it's a good question. So the vast majority of our investment portfolio is transitioning into our investment in CIF and Sierra Crest. But we did buy some loans just to keep the -- generate some interest income before these transactions close. So the intention is to use those liquid assets to put into our CLOs as that closes and/or sell them when we close Capitala and some of the other deals.

Okay. And then on the $60 million credit facility, you talked about one financial impact on increasing the duration. Is there any other impact on refinancing? Like do the assets increase? Or is it still relatively steady?

Yes. So if you take a step back, we've got a CLO that's outside of its reinvestment period. So we are in the market, what's called resetting it, so we're going to have to extend the investment period. So to your point, the assets that we're ramping now will go into that facility when it closes. So it will no longer be an obligation or not on the balance sheet of Mount Logan. And to your point, because there's more assets and because the investment period is longer, the fees, the duration of fees definitely go up. And depending on how big the CLO is, we may also get a little bit of a bump in terms of just run rate fees.

Okay. And on the CIF, you talked about adding additional salespeople in. And thanks for the update on the year-to-date performance of just under 8%. So these salespeople, are these Mount Logan salespeople kind of talking to, I guess, various distribution channels in the U.S. like through wirehouses and RIAs, et cetera?

Yes, exactly. So we're doing 2 things on that front, which are really interesting. So income from CIF is well above our plan. And the reason for that is partially because of performance. We've had really -- we've had top-tier performance since we've closed. But secondly, we haven't added as many salespeople as we would have liked. So we're in the process of adding those people now. Those people will sell CIF in the U.S. to the IBD channel and the RIAs, exactly what you just said. We're also hoping to use them to potentially launch some products in Canada. And obviously, there's been some recent news about some changes in the Canadian retail channel. So we think that opens up a really big opportunity for us to potentially start a new business in Canada. So I think the sales force is very strategic for us, and it's a big, big focus of the management team right now.

And Ted, what is that news on the retail channel that changed that could provide this opportunity?

Just that there's a big player in the Canadian credit market who is in the retail channel that is going through some difficulties. And so a potential -- we were going to do this anyways, but it potentially opens the door for new entrants into the retail channel.

Okay. And just lastly, I guess, since our last update, any update towards your M&A pipeline to expand into this alternative asset manager after being pretty acquisitive over the last couple of quarters?

Yes. I mean, the hardest working man on Wall Street is our CFO from all this integration. But we have 2 near-term M&A announcements that we expect to wrap up probably over the next 6 weeks. So we continue to be very focused on it. Both of which are minimal amounts of consideration, given what -- versus what we're actually getting. So both are very strategic for us. And the 2 platforms we're about to announce, we expect to be similar to CIF actually, businesses we can grow. So something like a Capitala is -- generates a lot of cash for us. That's going to be a big cash flow generator. And we think we actually might be able to grow it. But the 2 announcements we're about to make are growth platforms for us. So we get earnings plus growth, which is pretty strategic for us.