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 Second Quarter 2021 Results Conference Call. 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 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. Please note, today's event is being recorded. I would now like to introduce your host for today's conference, Mr. Ted Goldthorpe, Chairman and 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 second quarter 2021 results call. During the call, we'll be referring to the information provided in the financial statements, the MD&A and the associated news release for the quarter, all of which were released last Thursday and are available on our website and on SEDAR. Joining this morning is our Chief Financial Officer, Jason Roos; and my Co-Presidents, Matthias Ederer and Henry Wang. Overall, we are very pleased to announce that Mount Logan had another successful quarter, most notably with record revenue and continued growth in fees attributable to our asset manage activities. Before we speak to our financial results for the quarter, I will provide an update on the transaction with Logan Ridge, our announcement related to the acquisition of Ability Insurance Company, our transaction with Crown Private Credit Partners, all of which highlight our year-to-date progress with our existing platforms, and we'll provide some brief remarks on the general market conditions outlook. First of which, I will speak to our transaction with Capitala, which was closed on schedule on July 1, 2021. In April, we publicly announced this transaction where our wholly-owned U.S. subsidiary, a Mount Logan management, that become the investment adviser of Capitala Finance Corp., which was renamed Logan Ridge upon closing. Logan Ridge is a U.S. publicly-traded business development company or BDC, with approximately $263 million in total assets as of June 30, 2021. Now trading under the NASDAQ, under the ticker LRFC, the market has responded well to new management with the share price up over 70% since the original announcement of the transaction in April. As the investment adviser of Logan Ridge, Mount Logan management is entitled to 1.75% annual base management fee on the gross assets as well as an incentive fee tied to performance. Since the transaction announcement, we've worked with Logan Ridge management team around certain initiatives, one notable change being significantly derisking Logan Ridge balance sheet by repaying $71 million in debt. Now that we've closed the transaction, we were actively working to optimize Logan Ridge's capital structure and to rotate out of nonincome-generating investments over time. Longer term, our objective is to lower operational costs and increase scale, which we believe will enhance value for stockholders and provide Mount Logan with a stable and recurring asset management fee stream underpinned by permanent capital. Lastly, this transaction significantly expands Mount Logan asset management revenue and acts as a potential growth platform for future opportunistic BDC transactions. We believe that this platform has a lot of optionality for us to grow over time in an accretive manner for Mount Logan shareholders. In May, we announced our agreement to acquire 100% of the equity of Ability Insurance Company. Ability is a Nebraska-based insurance company and reinsurer of long-term care policies with approximately $900 million of invested statutory assets as of the end of last year. This is a highly transformational and accretive transaction for Mount Logan. By way of background, insurance is increasingly one of the largest areas of growth in the global investment environment and insurance demands attractive assets and returns to meet future obligations. Accordingly, there's a highly complementary relationship between insurance and asset management. Leading global asset management franchisers are acquiring insurance businesses to leverage their permanent capital base in exchange for complementary investment sourcing and management capabilities. Mount Logan's acquisition of Ability is no exception. We believe this transaction will combine 2 companies that provide products and services that are in high demand, insurance solutions and asset management. In terms of the transaction structure, Mount Logan has proposed to purchase Ability for $20 million to be satisfied through a $15 million unsecured seller note and a $5 million in common shares of Mount Logan Capital. The implied valuation of Ability is highly attractive as the purchase consideration represents a significant discount to statutory book value. A key element of the transaction is that Mount Logan management, Mount Logan's wholly-owned investment adviser subsidiary has proposed to manage a meaningful portion of Ability's assets, thus increasing our assets under management and generating meaningful recurring management fees. In terms of any legacy insurance risk, Ability is unique in that its existing claims risk has been largely reinsured and is effectively in runoff and Ability is no longer active in ensuring or reinsuring long-term care risk. Furthermore, the seller has also agreed to provide protections that help backstop with the performance of the existing portfolio and limit the risk associated with the existing long-term care liabilities. As Ability's long-term care exposure matures, Ability will transition to building an annuity reinsurance business. As part of the transaction, Mount Logan will further invest $10 million of capital into Ability to strengthen Ability's balance sheet and launch a platform for the reinsurance of annuities, which is expected to reinsure $150 million of fixed annuities within 6 months following the close of the acquisition. We worked closely with the seller of Ability over the last 18 months to develop an in-depth business plan on how to create significant value for both Mount Logan shareholders and Ability's policy holders. Our three-pronged approach is: one, leverage Mount Logan's private credit sourcing capabilities to increase Ability's portfolio yield; two, structurally mitigate any downside risk related to the existing portfolio and liabilities via reinsurance and backstop agreements; and three, a plan to pivot ability away from long-term care risk to annuities. We believe executing on the above will position Ability for long-term growth and create an attractive high ROE business unit for Mount Logan. Ability acquisition is highly strategic to Mount Logan for a number of aforementioned reasons. But to summarize, this will add a stream of highly recurring management fees, presents minimal risk related to legacy liabilities, it is being acquired for a compelling valuation and enable us to create long-term equity value through transition ability into a sustainable reinsurer of annuity risk. We also believe that this will provide compelling organic growth for our company going forward. On July 23, 2021, following a public hearing, the Nebraska Department of Insurance formerly approved Mount Logan's proposed acquisition of Ability, which paves the way for our intended close in the fourth quarter. We are very excited about the transformative potential of this acquisition for Mount Logan and look forward to welcoming key members of Ability's management team to our company. For more information on our transaction with Ability and the broader thesis, you can refer to our updated investor presentation on our website. In July, Mount Logan acquired a minority stake in Crown Private Credit Partners, a new credit manager focused on private debt opportunities in the Canadian middle market. Crown Private Credit is a spinout of Crown Capital Partners, a publicly traded Canadian corporate financing business that was seeking to divest its private credit segment. As a founding shareholder, Mount Logan partnered with Crown's management team and 2 chartered banks to effectuate the carve-out of the private credit business. At its inception, Crown Private Credit took over the management of an existing fund previously managed by its former public company owner with a net asset value of approximately CAD 190 million. The management of this existing fund enables Crown Private Credit to self-fund its growth as it develops new products and partnerships with third-party investors. To Mount Logan, this partnership with Crown Private Credit as an additional asset management fee stream expands our exposure to the growing Canadian middle market, offers the opportunity to codevelop new fund products and aligns us with an experienced management team and 2 multibillion-dollar Canadian shared banks. In regards to our CLO platform, it continues to perform well and produce a steady stream of management fee income. We remain focused on actively leveraging our team sourcing and underwriting capabilities to optimize the asset base of the CLOs, reposition the portfolios and rotate into higher quality loans without sacrificing yields. In May, we entered into a warehouse facility of up to $60 million to ramp a portfolio of loans. Our portfolio ramp is in progress, and we expect to terminate our warehouse facility over the next couple of months along resetting our 2018 CLO, which, if successful, will increase the duration of our asset management fees tied to this vehicle. Moving on to Sierra Crest. Through our minority interest, we received a portion of the economics connected with the advisory contract for Portman Ridge, a publicly traded BDC with approximately $650 million of assets as of June 30, 2021. Portman Ridge continues to grow organically and via acquisition, most notably completing its merger with Harvest Capital Credit Corporation on schedule in June of 2021. Alongside this merger with Harvest, Mount Logan took the opportunity to increase its ownership stake in Sierra Crest from 21.4% to 24.99%. This minority investment has delivered compelling performance thus far. And as Portman Ridge has developed a reputation as an acquirer of choice in the BDC space, we look forward towards continued scaling of that entity that will result in a larger base of fee-generating permanent capital that will flow to Mount Logan. In relation to our interval fund known as the alternative credit income fund or Alt-CIF. The fund has over $290 million of assets as of June 30, 2021, and performance has been strong with year-to-date returns through the end of July approaching 11%. We strongly believe the retail channel and Alt-CIF's fund structure is highly attractive, and we continue to invest in Alt-CIF to support its growth, most notably adding 2 sales professionals in June. As COVID-19 travel restrictions have started to lessen. We have also had the fundraising team and Alt-CIF's portfolio manager begin to travel for sales meetings across the United States in order to drive greater fund subscriptions. 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 Alt-CIF, we look forward to growth of the fund in the coming years. Turning briefly to current market conditions. The second quarter continued where the first quarter left off with strong economic tailwinds and continued low interest rates. In terms of the liquid loan benchmarks, spreads during the second quarter continued to tighten on average compared to the first quarter. Broadly speaking, transaction volume in the loan markets remained strong in the quarter, including both new investment opportunities through M&A activity as well as refinancing activity. As before, we note that spreads remain wider in direct loan origination -- in the direct loan origination market relative to a liquid credit market and our ability to use the breadth of our platform to lead and structure transactions should generate consistent, attractive risk-adjusted returns for the various funds we manage under Mount Logan management. As of quarter end, Mount Logan held $18.3 million of first lien senior secured term loans on its balance sheet, of which nearly all are expected to be contributed to our CLOs as part of their ongoing reset transaction. Other investment holdings on our balance sheet totaling $23.8 million are related to our exposure to Alt-CIF, our minority stake in Sierra Crest and 2 small equity holdings. 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 August 24. With that, I'll turn over the call 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 second 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 June 30, 2021, we generated $1.4 million total revenue, an increase of 53% year-over-year and 6% quarter-over-quarter. This quarter continues to illustrate the trend of our revenue profile being increasingly attributable to our asset management activity, which comprised of 59% of total revenue for the quarter. Our management fees related to our CLOs were approximately $344,000 for the quarter. For the net earnings attributable to the alternative credit income fund, this is captured as $48,000 under management fees and has $249,000 in interest income. Mount Logan's minority stake in Sierra Crest, the company recognized $278,000 of revenue for the quarter. As Logan Ridge closed on July 1, there are no management fees attributed to Mount Logan in the second quarter. However, this will flow through in the third quarter and beyond. On the expense side, for the quarter ended June 30, we incurred $948,000 in transaction costs and professional fees, an increase quarter-over-quarter as a result of the elevated acquisition activity in the second quarter, inclusive of our transaction with Logan Ridge and the progression of our transaction to acquire Ability. Other operating costs, including directors' fees, compensation, marketing, regulatory and shareholder relations and other general and administrative costs totaled $436,000 for the quarter, aligned with our previous quarter. In the quarter ended June 30, Mount Logan paid $237,000 net interest, which mainly relates to our $5.3 million credit facility related to our acquisition of Sierra Crest and our short-term leverage facility we are using to ramp a portfolio in connection with the CLO reset transaction. We incurred $196,000 in noncash amortization expenses related to the management contracts for our CLOs, which are treated as intangible assets on our balance sheet. Our deferred tax asset increased in value quarter-over-quarter based on an increase in expected income attributable to Canada. In the quarter, we faced a net realized gain on investments of $49,000 and a net unrealized depreciation on investments of $25,000. Our total and comprehensive loss was $204,000 for the quarter or $0.01 per weighted average share. As of June 30, 2021, Mount Logan's balance sheet reflected total assets of $73.8 million, total liabilities of $30.7 million and shareholders' equity of $43.2 million. While shareholders' equity and net asset value per share remained relatively steady quarter-over-quarter, our assets and liabilities increased by $17.8 million, primarily related to the investment activity connected to the ramp of the portfolio for our CLO and a related draw on our warehouse leverage facility to fund this. Our asset balance at quarter end primarily consisted of $46.2 million in our investment portfolio, our $9.4 million balance in cash and restricted cash, a $9.6 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 of our CLO. 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 and $10 million drawn on our $60 million revolving warehouse facility that is being used to ramp a portfolio of loans in connection with the transaction to lose that one of our CLOs. Lastly, one notable liability of the client investment associated with the 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 assets in the fourth quarter of last year, we received our first distribution in the first quarter of 2021. We meet our first distribution of CAD 0.02 per CVR in June 2021 and will evaluate further distributions in accordance with the received for further distributions from Cline. 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 so far this year between Logan Ridge, Ability, Crown Private Credit and our increased stake in Sierra Crest has been a very eventful second quarter, and we're very proud of the growth of Mount Logan and its ongoing emergence as a diversified asset management platform. The fee generation from Logan Ridge will begin to impact our financial results in the third quarter, and you'll see our composition of earnings continue to shift towards being underpinned by recurring management fees. The closing of Ability is a major focus going into the fourth quarter, and we look forward to folding the scale of insurance operations into Mount Logan as we nailed 2 high supplementary business lines together to form a hybrid asset manager and insurance solutions model. Looking ahead, we are in solid financial shape and we have continued to position Mount Logan for long-term success and growth in fee-related earnings. You're now seeing the results of our team's hard work on a number of strategic transactions over the past year, and we firmly believe this will create value for our shareholders as they flow through our results in the coming quarters. This concludes our prepared remarks. We will now transition the call to a Q&A session, and if the operator could please coordinate.

[Operator Instructions] And the first question will come from Pratik Agarwal with Canaccord Genuity.

A couple of quick ones for me. First one, a follow-up on your Logan Ridge comment. I noticed that you reported this morning, and there was a lot of cleanup around reducing debt and write-down and sort of investments. Just wanted to understand as to the progress on Logan Ridge's portfolio transformation plan? And what major changes can we expect in that portfolio in the coming quarters? And my second one is more of a high-level question. Now that Logan Ridge and Crown Capital is closed and ability is on track, what next can we expect from Mount Logan in the next 12 months in terms of its M&A pipeline or leveraging investment in Crown Private Credit?

Okay. So the second question is a very good question. I think we've obviously executed a number of different M&A transactions over the last couple of quarters. And we've really been focused the last 3 months on execution. I think -- if you think about going forward, I would say our real focus would be organic growth of our Alt-CIF platform. And obviously, growth of our insurance platform, which both we can do organically. So I think you're going to see -- you're beginning to see some organic growth funded by the cash flows generated from our permanent capital vehicles. But we obviously will look at other things. We're looking to increase the scale of our CLO business. So we have some things going on in that subsegment. And obviously, we're always in a number of discussions on some other transactions. So I think to go forward, we feel really good about our growth. We think we can fund it with just our on-balance sheet cash, and we think there'll be -- with some good organic growth prospects. In terms of Logan Ridge, we also reported earnings on Logan Ridge recently. We've made a lot of progress, and we're way ahead of our plan in terms of repositioning. So we've paid down a lot of debt. We've been able to exit a number of portfolio companies earlier than expected, and the reposition is going quicker than we expected. So we are very, very excited about this acquisition. We've been surprised how quickly we've been able to reposition the portfolio so far just given the strength in end markets. And we now we're using that as a platform to try and grow. So we are looking at various different strategic alternatives for Logan Ridge to increase the scale and scope of their business.

And we have an earnings call later this morning on that. So more detail. We'll comment later this morning.

And the next question will be from Chuck Burns with CIBC Wood Gundy.

Definitely, you guys are making a lot of progress over the last couple of years for sure. Just a couple of quick questions. The Ability transaction, part of the cost is going to be satisfied and is 5 million in common shares of Mount Logan. Has it been deemed at what price for Mount Logan?