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 2021 results conference call. Before we begin, I'd 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 than 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 risk 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 under 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, 2021, which are available on SEDAR. 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 very much. Good morning, everyone, and thank you for joining us for our fiscal year-end 2021 results call. During the call, we will 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 last year and available on our website and on SEDAR. Joining me this morning is our Chief Financial Officer, Jason Roos; and Co-Presidents, Matthias Ederer and Henry Wang. Overall, we are very pleased to announce that Mount Logan had another active year and successful quarter, most notably with record revenue and continued growth in revenue attributable to our asset management business. Before we speak to our financial results for the quarter, I will provide an overview of the current breakdown of our business, highlighting our 2021 results with our existing platforms and our progress following the acquisition of Ability Insurance Company in the fourth quarter. Perhaps what best illustrates the progress that Mount Logan has achieved in 2021 has been our growth in AUM. At year-end, Mount Logan had an attributable AUM of $2.2 billion, doubling from where we were at the end of last year. As we think about the different funds we manage and have exposure to, we believe there are 3 key pillars to our business: Retail, institutional and insurance, and I will address each one separately. On the retail front, this encompasses our U.S. interval fund known as the Alternative Credit Income Fund or Alt-CIF, and 2 other products we are launching this year. Alt-CIF finished the year with over $250 million in assets, and most notably, our investment in the sales force has ramped fundraising activity, resulting in $10.6 million in fund subscriptions in the fourth quarter of 2021 and showing larger numbers for year-to-date 2022. Our focus remains on maintaining the attractive performance of Alt-CIF, which achieved an 8.6% return over the trailing 12-month period through February 2022. We believe the return profile and lower relative volatility will continue to differentiate the fund amongst our peers and alternatives. Lastly, we believe our redemption queue at the end of the fund has been cleared. Our past redemption queue has been cleared and are looking forward to maintaining the momentum and growing the fund on a net basis through 2022. Outside of Alt-CIF, we are launching a retail product alongside our joint venture partner, Crown Private Credit Partners, focused on the Canadian market, which we believe there is significant current market opportunity caused by other players exiting the market. In addition, our U.S. investment adviser subsidiary recently filed a form with the SEC to register the Opportunistic Credit Interval Funds or OCIF, a new interval fund focusing on high net worth channel in the U.S. with an investment mandate focused on special situations in private capital. The proposed structure will require a minimum $1 million commitment per investor and expected to be semi-permanent in nature with annual 20% redemption features at NAV. The continued growth of Alt-CIF, the launch of OCIF and the launch of Crown's retail fund should help drive organic growth in 2022. On our institutional side, this covers our BDCs and our CLOs, our permanent and longer duration capital. For Logan Ridge, we took over the management of this BDC on July 1 of last year and earned $2.2 million of management fees in the second half of 2021 on approximately $240 million of assets. Since taking over management, we have rapidly acted on objectives and implemented our standardized playbook of optimizing the capital structure, rotating of the legacy portfolio and reducing operating expenses. We successfully repaid the credit facility, obtained an investment grade rating on a new issuance of 5.25% notes and successfully delevered to 1.2x at year-end versus 2x at the end of 2020. During 2021, we made substantial progress repositioning the investment portfolio, having successfully monetized approximately $100 million of the legacy portfolio we inherited. In closing, we believe our continued efforts will create a more resilient BDC that will enhance value for shareholders and provide Mount Logan with a stable and recurring asset management fee stream underpinned by permanent capital. Mount Logan also has exposure to the Portman Ridge BDC through a minority interest in its investment adviser, Sierra Crest. Portman Ridge successfully grew through 2021 with organic growth and the acquisition of Harvest Capital Credit Corporation. Portman Ridge finished the year with nearly $650 million in total assets and the management contract continues to provide consistent quarterly cash distributions to Mount Logan. Between Logan Ridge and Portman Ridge, Mount Logan has 2 separate BDC fee streams connected to a sizable basis of fee-generating permanent capital. On the CLO side, this includes $642 million of AUM at year-end. The CLOs continue to perform very well and produced a steady stream of management fee income. After ramping up portfolio since May on Mount Logan's balance sheet, we completed the reset of one of our CLOs in December. This reset extended the life of the CLO by 3 years, thus increasing the duration of our asset management fee stream and demonstrating its quasi permanent nature. This reset was also highly beneficial as Mount Logan contributed its residual on-balance sheet assets into the CLO, converting our interest income to asset management fees. Overall, our institutional pillar is divided across a number of CLO and BDC funds and represents over $1 billion of Mount Logan's total attributable AUM. And lastly comes, insurance, our newest vertical. On October 29, Mount Logan closed its acquisition of 100% of the equity of Ability Insurance Company. As a reminder, Ability is a Nebraska-based insurer and reinsurer of long-term care policies with over $900 million of invested statutory assets as of the end of the year. This is a highly transformative and accretive transaction for Mount Logan. Mount Logan Management, our wholly owned investment adviser subsidiary, is now managing a significant portion of Ability's assets, thus increasing our AUM and generating meaningful recurring management fees. Since closing our deal, our team has been deeply focused on Ability's integration, reporting portfolio management, policy rate increases and laying a foundation for future growth. While derisking the investment portfolio, we have deployed idle cash and rotated from legacy assets into Mount Logan originated assets, improving the net investment yield by approximately 60 basis points since close. Furthermore, we expect that with continued portfolio transformation, we can achieve a further 100 basis points of improvement by year-end. Outside of refining the portfolio composition, another key initiative has been implementing rate increases on the legacy long-term care policies. To date, we received approval from states representing over 50% of annual premium, and we've submitted for increases in states, representing over 90% of our premiums. We expect these rate increases to begin flowing through into our second -- our results in the second and third quarter of this year. To the benefit of Ability's policyholders, we improved our risk-based capital, a minimum capital requirement metrics set by regulators from approximately 300% to 425% at year-end, ensuring that Ability is more than sufficiently capitalized. On the growth side, we signed a term sheet for a $150 million annuity reinsurance deal and are working through definitive documentation and regulatory approval. This will accelerate our transition from our legacy long-term care business, reduced volatility and help Ability to expand and transform into a broader insurance solution platform. Our Ability team has a number of other initiatives related to new structures to permit a larger allocation of private credit, greater operational integration, forecasting obligations with the state regulator's ongoing rate increase approvals, potential growth capital infusions and looking at other accretive opportunities in insurance. While substantial work remains, we are very pleased with our progress over the last 5 months since closing the acquisition. After working on the Ability transaction for nearly 2 years, we are working on our business plan. We are working on putting our business plan into action and believe continued execution on the above will position Ability for long-term growth and create an attractive, high ROE business unit from Mount Logan. Very simplistically, when you look across our 3 pillars, our business works by collecting management fees from our retail and institutional funds and using the proceeds to fund the growth of our insurance business. With the leverage inherent with the purchase of annuities, produces incremental assets, investment income and management fees resulting in mid-to-high teens returns on equity. Ability serves as the foundation to expand into insurance and an organic growth engine that we can complement with additional strategic asset management transactions. In terms of dividends in 2021, we paid CAD 0.02 per share each quarter, resulting in CAD 0.08 per share paid for the year. We're maintaining our dividend for the quarter, and we will be paying CAD 0.02 per share to shareholders of record as of March 31. With that, I'll turn the call over to Jason Roos, who will review the financial results for the year.

Thanks, Ted. Good morning, everyone. Before I summarize the results, I wanted to highlight our new segmented classification of our balance sheet and income statement. In light of our acquisition of Ability Insurance Company in Q4 2021 and its consolidation into Mount Logan's financial results, we now segment our financial statements between our asset management business, which consists of our activity related to the management of Logan Ridge, CLOs, Alternative Credit Income Fund, a stake in Sierra Crest and other investments in our insurance business, which consists of Ability insurance, a Nebraska-based insurance company transitioning from its legacy long-term care business to the reinsurance of annuities. I will now summarize our key highlights for the 2021 fiscal year and the fourth 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 year ended December 30, 2021, we generated $11.6 million of total revenue, an increase of 231% year-over-year and 66% quarter-over-quarter. Breaking it down by segment, we achieved $8.8 million in revenue attributable to our asset management segment, up 151% year-over-year and $2.8 million attributable to our insurance segment. As Mount Logan acquired Ability Insurance Company on October 29, 2021, the financial results cover the stub period from the closing date through year-end. Our fourth quarter continued to illustrate the trend of our revenue profile being increasingly attributable to our asset management activities, which comprise of approximately 70% of total revenue for the quarter for the relevant segment. Given we took over the management of Logan Ridge on July 1, 2021, we received only 2 quarters of management fees or $2.2 million in revenue in the second half of last year. Our CLOs generated approximately $1.1 million in management fees for the year. The net earnings related to alternative credit income fund, which comprised of interest income and servicing fees, was approximately $1.1 million. For Mount Logan's minority stake in Sierra Crest, the company recognized $1.3 million of revenue for the year and received $1.8 million in cash dividends for the year due to the timing of payments. Our cash distribution received in the fourth quarter was over $700,000, which we expect to be close to the run rate earnings potential given we upsized our stake in Sierra Crest in June and Portman Ridge has expanded to over $600 million in total assets. In terms of non-IFRS measures, our 2021 MD&A includes our first reference to fee-related earnings, or FRE, a metric used by asset managers on a supplemental basis that refers to revenues that are generally more stable and predictable in nature, less attributable expenses, namely compensation and associated operating expenses. Mount Logan's FRE was $4.7 million for the year ended December 31, 2021, up from $100,000 in 2020. The 2021 FRE does not fully capture Mount Logan's run rate potential, given it only factors in 2 quarters of management fees from Logan Ridge. For the asset management segment, expenses for the quarter ended December 31, 2021, were impacted by approximately $2.7 million in transaction costs and professional fees and increased quarter-over-quarter as a result of the closing and integration of Ability. Other operating costs, including directors' fees, compensation, marketing, regulatory and shareholder relations, insurance and other general and administrative costs, totaled $1.1 million for the quarter. For the quarter ended December 31, 2021, Mount Logan paid $1.3 million in interest, which primarily relates to our $25 million corporate credit facility and our $60 million revolving CLO warehouse facility related to our CLO reset, which was terminated in mid-December 2021. So our interest expense is expected to be lower on a run rate basis going into 2022. We incurred $199,000 in noncash amortization expenses related to the management contract for our CLOs, which is treated as an intangible asset on our balance sheet. Our deferred tax asset had a net noncash write-down of $2.6 million quarter-over-quarter based on a decreased assessment of income attributable to our Canadian operations. This was partially offset by a positive assessment of income attributable to our U.S. operations. For the Insurance segment, I will provide a brief walk-through of the line items given the addition of the segment this quarter. On the income statement, the lines related to Ability's income from premiums represents the total amount of insurance premiums collected by Ability from policyholders less the premiums that are ceded out or simply put, paid to our reinsurance partners in exchange for their coverage of the majority of claim payments to be made to policyholders. This amount is negative $2.4 million, reflecting the extensive reinsurance coverage in place over the long-term care business. The next line, net investment income represents the interest and dividend income, net of investment expenses generated from our insurance-related investment portfolio, which was $6.5 million for the year. On the expense side, the primary item is the net policy benefits and claims, which represents the change in insurance contract liabilities on the balance sheet, net of amounts recoverable from reinsurers. The amount is negative $33.2 million this quarter, primarily driven by the increased investment yield achieved on Ability's asset portfolio following the acquisition, resulting in a higher discount rate in the actuarial calculation and resulting in a decline in net insurance contract liabilities. The administration fee of $1.3 million represents the fees paid to administer Ability's operations, inclusive of servicing the insurance policies and related statutory actuarial work. To put context around earnings this quarter, Mount Logan is in a transitionary period for its business model, having just acquired Ability in the fourth quarter of 2021. Accordingly, the financial statements reflect these activities and transaction-related costs, which have been incurred in Q4, whereby the sustainable cash earnings potential of the business is expected to grow in future quarters. Mount Logan incurred a number of nonrecurring or noncash items inclusive of onetime transaction-related costs and the noncash by recurring amortization of intangible assets, elevated professional fees, interest on the debt facilities that has since been significantly reduced and the noncash deferred tax expense. For the year ended December 31, 2021, Mount Logan achieved a basic EPS of $1.55 and an adjusted basic EPS of $1.77. This increase in EPS was largely attributable to the noncash change in insurance contract liabilities and reinsurance assets. With the closing of the Ability transaction behind us, we expect EPS to normalize going forward after adjusting for any change in actuarial balances that will impact our insurance segment. As of December 31, 2021, Mount Logan's balance sheet reflected total assets of $1.4 billion, total liabilities of $1.3 billion and shareholders' equity of $85.3 million. For the asset management segment, our cash increased by $12.3 million quarter-over-quarter to $14.4 million, primarily due to the receipt of cash related to the sale of part of the investment portfolio pledged to our CLO warehouse. Similarly, our balance and investments declined by $36.3 million as Mount Logan divested a material portion of its on-balance sheet loan portfolio to the CLO upon reset in mid-December. Our intangible assets of $22 million represents Mount Logan's interest associated with the management contracts of the CLOs and Logan Ridge. At year-end, the liabilities related to our asset management segment predominantly includes outstanding debt obligations of $25 million drawn under our corporate credit facility, a $15 million seller note issued in connection with our acquisition of Ability and a $4 million seller note issued in connection with our acquisition of the management of Logan Ridge, show net of deferred financing costs. Lastly, one notable liability is the Cline 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 in 2018. Last year, we received our first distribution and made a distribution of CAD 0.02 per CVR in June 2021. And following the receipt of a second distribution, CVR holders of record as of March 29, 2022, will be receiving a distribution of CAD 0.07 per CVR on April 7. We will evaluate further distributions in accordance with the receipt of further distributions from Cline. For the Insurance segment, the largest asset is the $881 million in investments that Ability has title to. The $330 million of reinsurance assets reflects the estimate of the net claims recoverable by Ability from reinsurers based on the long-term care policies and prevailing actuarial assumptions. On the liability side, insurance contract liabilities is the largest item at $943 million, which represents the estimated claims payable to Ability's policyholders before any reinsurance recoveries based on policy data and actuarial assumptions. Based on mortality, morbidity and investment yield assumptions, we expect this line item to experience some volatility quarter-over-quarter. However, we do not view any short-term volatility in assumptions, is fundamentally changing the way we operate and grow Ability. The funds held under reinsurance contracts is an offsetting liability for the fair value of investments held of $291 million, which represents reinsurance collateral under the funds withheld reinsurance agreement entered with a third-party reinsurance partner. With the recent Ability transaction, we have spent a significant amount of time with our internal accounting team, our vendors and administrators and other professionals to integrate our accounting practices and revise our presentation. We continue to refine the foundation of Ability such that it can serve as a platform that can scale materially over time. Overall, in the long-term, we expect to increase book value in our insurance segment. And as Mount Logan management continues to grow its allocation of managing our insurance assets, we expect the combined synergies between asset management and insurance to benefit our shareholders. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thank you, Jason. In closing, I want to reiterate the transformation that Mount Logan made in 2021. Between Logan Ridge, Ability, Crown Private Credit, our CLOs and our new corporate credit facility and our increased stake in Sierra Crest, it has been an eventful year, and the fourth quarter has been no exception. We now have a diversified asset management platform underpinned by recurring fee-related earnings across a variety of different fund products. Across our 3 pillars of retail, institutional and insurance, our focus remains on organically growing each vertical and complementing that growth with future strategic transactions. The integration and scaling of Ability remains a key focus for the rest of the year as we combine a sizable insurance business into Mount Logan and begin to realize the synergies of melding 2 highly complementary business lines together. We intend to continue to invest in Ability to grow it, and we will evaluate other strategic opportunities and contrast them with the implied high teens return on equity, we expect to achieve by investing capital into Ability. We have high conviction in our existing business performance on a run rate basis and are very well positioned for future growth. That concludes our prepared remarks. We will now transition the call to a Q&A session, if the operator could please coordinate.

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

Maybe for Ted or Jason. Jason, you referenced the asset management FRE of $4.7 million for 2021. Anything unusual in that number for 2021 may be related to investment income or on the cost side?

Yes, I don't think so. I'd say that the thing to highlight there is it only reflects about a half a year of Logan Ridge management fees coming in. So we had $2.2 million of management fees coming in from Logan Ridge, $1.1 million of CLO management fees and about $1.3 million related to the alternative credit income fund there. Next year, we expect that number to be higher just given the extended time that we have with Logan Ridge.

And maybe because we could kind of see the revenue that you've kind of provided in the past, the fee-related revenue. Can you remind us what margins, FRE margins, I guess, 2022 is going to be higher? Or would 2023 really kind of maybe show the true power of the margin expansion?

Yes. I would say, 2022, we would -- well, I guess, we would expect a much higher margin. Like if you were to look at the asset management segment, a lot of that, I guess, net negative margin, if you were to look at the income over expenses for the year, a lot of that is onetime transactional and nonrecurring activity or expense related to the onboarding and the integration of Ability. So we've provided some guidance in the MD&A that would suggest about a $4.2 million reversal of some of that expenses as being onetime integration and transaction-related costs. So backing that out, you would get to a -- and also backing out some of the noncash amortization of the intangible asset related to our CLO as you'd get back to a $1.5 million number for the year net margin.

And then, Ted, the Ability close was partial in the quarter, I think perhaps on that. And, Ted, and just going through the financial statements and kind of what you talked about in terms of certain initiatives. Perhaps you can kind of break down for us what we can expect on that initiative side over the next 12 to 18 months because there's a lot of moving parts to deal with there?

Yes, you're right. And that's why we really try to break out our insurance business versus asset management. So I think what you'll see us do is there's a number of things we can do that are -- that don't involve us issuing any equity to grow organically Ability. So I think you're going to see us do some things both at the Ability level and potentially at the Mount Logan level to provide additional capital to that business. And as we talked about in our prepared remarks, we've already entered into one reinsurance agreement to buy annuities and my guess is we'll ramp up more of those. And so the more we do of that, obviously, the more of our asset base becomes "lower risk." And obviously, with every dollar we put into the vehicle -- with every dollar we put in the insurance company, we obviously generated incremental asset management fees. So I think you're really going to begin to see the flywheel effect of this. And Jason kind of guided how the asset management business is going to look this year. I think you're going to see real material -- you're going to really see some material asset management fee growth from Ability kind of run through our income statement the next couple of quarters.