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 Third Quarter 2022 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 enduring 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 actual 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, 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. Good morning, everyone, and thank you for joining us for our third quarter 2022 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 quarter, 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 my Co-Presidents, Matthias Ederer and Henry Wang. Overall, we are pleased to announce that Mount Logan had another solid quarter with continued growth in revenue for the overall business as we continue to execute on our strategic plan amid a challenging market backdrop. Before we speak to our financial results for the quarter, I will provide an overview of the notable highlights and an update on our 2 key business segments: asset management and insurance. Our Asset Management segment encompasses our previously discussed retail and the institutional businesses. Our retail business includes our U.S. interval fund known as the alternative Credit Income Fund, or Alt-CIF, and the recently launched opportunistic credit interval fund or OCIF. OCIF is a new interval fund focused on the high net worth retail channel in the U.S. with an investment mandate focused on special situations and private capital which leverages our best-in-class institutional fund track record. The institutional business covers our BDCs and CLOs, which are permanent and longer-duration capital. Across our Asset Management segment, we generated $1.7 million in management and servicing fees on an asset base of over $2 billion. On the retail side, Alt-CIF had another solid quarter with our sales force seeing sustained momentum, which resulted in approximately $21.3 million in new fund subscriptions in the third quarter of 2022, up 215% year-over-year and up 34% quarter-over-quarter. We continue to onboard additional distribution partners and scale our sales team. Outside of Alt-CIF, we launched OCIF in July, and we've been working to scale this fund since its launch and have been actively deploying capital to build an investment track record to leverage and begin to scale in earnest in 2023. We're also very excited about our joint retail fund product with our joint venture partner, Crown Private Credit Partners, and expect it to launch early next year, marking our entry into the Canadian retail channel. On the institutional side, the stability in our BDC and CLO fee streams remain a pillar of the business, which provide a degree of predictability in Mount Logan's top line performance. Logan Ridge continues to optimize the legacy portfolio with over $145 million of the legacy portfolio or 65% of the portfolio's fair value we inherited, [ not ] monetized or realized. As of the third quarter, Logan Ridge had an asset base of over $208 million. Mount Logan also maintains its exposure to the Portman Ridge BDC through its minority interest in Portman Ridge's investment advisor, Sierra Crest. Portman Ridge finished the quarter with over $630 million of total assets, and the management contract continues to provide consistent quarterly debt cash distributions to Mount Logan. Between Logan Ridge and Portman Ridge, Mount Logan has 2 separate BDC fee streams underpinned by sizable basis of fee-generating permanent capital, both of which have continued to perform well in an environment of greater market volatility and challenging macro headwinds. On the CLO side, AUM for the third quarter was $647 million. The CLOs continue to perform well and produce a steady stream of management fee income. Our institutional pillar is diversified across a number of CLO and PVC funds and represents over $1.4 billion of assets. On the insurance vertical, we continue to progress on the integration and optimization of ability through both, our portfolio and annuity business. We are actively building out the team, and have identified several talented individuals, which we believe, will be key to help unlock the value of the ability and support the business over the coming years. As a reminder, Ability is in Nebraska-based insurer and reinsurer of both, long-term care and annuity policies, with approximately $830 million of invested assets as of the end of this quarter. Mount Logan Management, our wholly owned investment advisor subsidiary manages a significant portion of Ability's assets, which continues to grow as we increase our annuity exposure and originate attractive private credit assets. Overall, Ability has performed in line with expectations for the third quarter and our original initiatives continue to bear fruit. Our focus remains on improving the portfolio yield by optimizing the investment holdings, scaling the annuity business and enhancing the existing insurance book. On the portfolio side, we continue to invest through our on-balance sheet CLO structures, which allow Ability to increase its allocation to private credit in a capital-efficient manner. This initiative is driving increases in overall portfolio yield with private credit assets being originated at over 8% yields in the quarter. In regards to growth, we're 60% of the way to completing the initial reinsurance deal we signed in the second quarter of this year. The first deal consisted of an initial block of annuity policies that will ramp up over time to over $150 million in premium. During this quarter, we added an additional $100 million agreement under similarly attractive terms. Both deals accelerate our transition from our legacy long-term care business, reduce volatility and help Ability expand and transform into a broader insurance solutions platform. Regarding enhancing our existing insurance book, premium rate increases rolled through additional states and have begun to flow through our results. As many of you have seen, following quarter end, Mount Logan also announced, it obtained a $7.5 million loan to support growth at Ability. The loan carries a fixed PIK interest rate of 7.5%, which we believe is an attractive cost of capital in the current environment. Proceeds from the loan will be contributed to Ability and used to support reinsurance of additional annuities to help grow Ability's AUM and further diversify the business away from long-term care. Although we are still in the early innings of executing on Ability's long-term strategy, we strongly believe that continued progress on the above initiatives will position Ability for long-term growth and create a highly complementary business unit for Mount Logan. We remain focused on increasing the management fees that the insurance business generates from Mount Logan, which is driven by the growth strategy mentioned earlier. Finally, we will be maintaining our dividend for the quarter, which will pay CAD 0.02 per share for shareholders as of record as of November 21. Before turning over the call to Jason Roos, I want to reinforce the excitement our team has about the progress being made at Mount Logan. We are actively exploring ways to grow our business and maximize value across the platform, consistent with our long-term objectives. We have a team that is committed to delivering results for all stakeholders and remain excited about Mount Logan's future. With that, I'll hand over the call to Jason Roos, who will review the financial results for the quarter.

Thanks, Ted. Good morning, everyone. Similar to our last set of quarterly filings, we segment our financial statements between our asset management business and our insurance business. I will now summarize our key highlights for the third quarter of 2022. 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 our Asset Management segment in the third quarter of 2022, we successfully launched our new retail fund with an opportunistic credit investment strategy. In addition, during the third quarter 2022, we entered a strategic arrangement to provide sub-advisory services to a recently launched fund in the United States that provides credit-related investment opportunities to retail investors further growing our asset management fee base. The Asset Management segment generated $1.7 million of revenue for the third quarter 2022. Breaking down our asset management revenue further, our CLOs generated approximately $260,000 in collateral and management fees for the quarter. In regard to our BDCs, Logan Ridge generated approximately $1 million in management fees. And with our minority interest in Sierra Crest, the company recognized over $235,000 of attributable revenue for the quarter. Our asset management revenue decreased by $600,000 or 25% quarter-over-quarter due to reduced interest and dividend income and temporary NAV compression along with incremental operating costs associated with our investment in our growing retail platform. In terms of non-IFRS measures, our fee-related earnings, or FRE, which deducts the attributable operating expenses from our asset management-related revenue, was $1.5 million for the quarter, which is slightly down from prior quarter FRE. For the Asset Management segment on the expense side, for the quarter ended September 30, we incurred approximately $3 million in expenses, which is down from prior quarter by approximately $100,000. For the quarter ended September 30, Mount Logan incurred $900,000 in interest and credit facility expenses, which remain -- which mainly relates to our $28 million corporate credit facility and $15 million seller note related to Ability. Our interest expense increased quarter-over-quarter due to increased borrowing and the higher market interest rates. 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. Moving on to our insurance business. We had total revenue this quarter of $6.4 million, which was primarily due to new premium growth through the reinsurance of annuities, including our second annuity reinsurance agreement of up to $100 million of premiums, which was newly executed during the quarter. This was partially offset by mark-to-market losses on portions of the investment portfolio as a result of increasing interest rates. Overall, given the current investment portfolio and liability structure of ability, we expect that rising interest rates will have a long-term benefit to Ability's capacity to generate investment yield in the form of net investment income. In our MD&A, we present a non-IFRS measure called insurance core earnings, which aims to assist investors in understanding the normalized earnings capacity of our insurance segment by attempting to exclude the direct impact of changes in interest rates and actuarial methods, along with a number of other items. For the 3 months ended September 30, 2022, our insurance segment generated $7.1 million of core earnings compared with negative $900,000 in the previous quarter. The increase in core earnings was driven in part by minimal realized losses on the net investment portfolio this quarter, compared with approximately $3 million in the previous quarter. Another key driver was increased net investment income on the investment portfolio of $1.5 million, net of investments held as collateral under reinsurance agreements. The remaining increase quarter-over-quarter was primarily due to other reserve changes, not directly related to the market interest rates or investing activities. For the quarter ended September 30, 2022, Mount Logan achieved a basic earnings per share of $0.88, which increased by $0.48 per share from the prior quarter amount of $0.40 per share. The quarter-over-quarter increase in earnings per share was primarily due to investing activities, including the noncash change in insurance contract liabilities and reinsurance assets, which were partially offset by unrealized capital losses on the insurance segment investment portfolio as a result of a significant increase in market rates during the quarter. As of September 30, 2022, Mount Logan's balance sheet reflected total assets of $1.3 billion, total liabilities of $1.2 billion and shareholders' equity of $96.4 million. On the Asset Management side of the balance sheet, our investments declined by $3.2 million as a result of our ongoing transition, away from interest-bearing assets held within our Asset Management segment and focused on growing fee-based revenue streams. The third quarter 2022 cash balance increased by $3.4 million, primarily due to the additional borrowing from our existing credit facility. Our intangible assets of $21.5 million represents Mount Logan's interest associated with the management contracts of the CLOs and Logan Ridge, which remained relatively unchanged. At quarter end, the liabilities related to our Asset Management segment included outstanding debt obligations of $28.3 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, shown net of deferred financing costs. Lastly, 1 notable liability is 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 Marriott Resource Corp prior to the plan of arrangement in 2018. In the first quarter of 2022, we received a cash distribution, and made a second distribution to CVR holders of CAD 0.70 per CVR in April. We will evaluate further distributions later this year in accordance with the receipt of further distributions from Cline. On the insurance side of the balance sheet, the largest asset is the $834 million in investments, which decreased in value by $17.9 million from the previous quarter, largely due to mark-to-market impact from rising interest rates. The $244 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 are the largest item at $808 million, which represents the estimated claims payable to Ability's policyholders before any reinsurance recoveries determined using actuarial assumptions applied to underlying policy data. As mentioned last quarter, based on mortality, morbidity, interest rate, market interest rate movements and investment assumptions, our insurance assets and liabilities can experience some volatility quarter-over-quarter. However, we do not view any short-term volatility and assumptions as fundamentally changing the way we operate and grow Ability. Our book value increased by 25% quarter-over-quarter. We expect the compound book value in our insurance segment over time. And as Mount Logan management continues to grow its obligation of managing Ability's insurance assets, we expect to combine synergies between asset management and insurance to yield economic benefit to Mount Logan Capital shareholders. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thank you, Jason. In closing, though we did not close on any strategic transactions in the quarter, we continue to evaluate and seek opportunities which will position ourselves well for the future growth. We believe, there's significant potential underpin the synergistic relationship between the asset management and insurance segments, and we have full conviction in growing both businesses nicely. In the period of rising rates and market volatility, we continue to look for areas of growth, both for credit as an attractive asset class and for potential strategic transactions with other asset management platforms. We have a robust M&A pipeline at accretive levels that will further scale Mount Logan. We're in a good position to capitalize on some of those opportunities and look forward to growing the business, improving liquidity of the stock and generating value for our shareholders. This concludes our prepared remarks. We will now transition the call to a Q&A session, if the operator can please coordinate.

[Operator Instructions] The first question comes from the line of Scott Chan of Canaccord Genuity.

I think, as you mentioned -- so on the [indiscernible] side, you're looking to going to the market, both in the U.S. and Canada. And just from your perspective, and I kind of read a lot, but it is the demand for private credit and assets [indiscernible] year to date. I just wanted to kind of get your thoughts on that right now.

Sorry, you said the demand has not been -- sorry, can just repeat that last part of it? You broke up there.

The demand for private credit like funds or assets seems to be quite higher in this environment. And I just wanted to get your thoughts on it. And maybe [indiscernible] the banks for me out a little bit and maybe it's because the yield is just that are higher in this marketplace.

Yes. So it's a great question. So there's an overall -- it's overall a very, very tough fundraising environment, just given what's happened in the markets. It's also tough fundraising environment given what's called the denominated effect where people are -- due to the losses on the liquid side of their balance sheets are facing higher allocations to illiquid assets. That being said, returns on private credit for an individual loan has doubled in the last 6 months. And I would argue, actually, for better companies and better risk because spreads are wider, and SOFR has gone from 30 basis points to 450 basis points. And so it's a very, very compelling -- we're making first-lien loans today at 11% to 13% that are very, very, very well downside protected and very well covered by enterprise value. And that's a pretty compelling offering vis-a-vis buying public equities. So I think, it's a very compelling offering. I think, people are all looking for places to put money in safe places, given the uncertainty out there. So it should be a really good time for us. And we think, it's part of the reason we're launching both, in Canada and the U.S.

Yes. I would say that's evidenced by the growth prescriptions that we're seeing on our alternative credit income fund, like we're seeing this quarter had the highest amount of subscriptions that we've seen in 5 quarters.

Is that your existing subscription you're talking about or your new one?

That's the existing one.

And as you know, ramping new funds takes a long time just because to get the machine going. But as Jason is alluding to, CIF is really hitting its ride and raising a lot of money right now. And so I think, it shows that once you get the kind of train -- once the train leaves the station, it becomes pretty compelling for our shareholders.