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 Fiscal Year 2022 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 -- statements reflect the company's current views with respect to future events and are subject to risks and uncertainties and assumptions which we have made in drawing the conclusion 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's Capital 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, 2022, 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 now begin.

Thank you, and good morning, everyone. We appreciate you joining us today for our fiscal 2022 results call. During the call, we will refer to information provided in the fourth quarter and full year 2022 press release, MD&A and consolidated financial statements, all of which were released last week and are available on our website and on SEDAR. Joining me this morning to discuss our results and positive outlook for the business is our Chief Financial Officer, Jason Roos; and my Co-President, Henry Wang. As a reminder, all references to dollar amounts on this call are in U.S. dollars unless otherwise stated. Overall, the fourth quarter was another strong quarter for our business despite the continued softness across the market and economic landscape. We are pleased to announce that we will be maintaining our dividend for the quarter, which will pay CAD 0.02 a share distribution for shareholders as of record as of April 4, which will mark our 14th consecutive quarter of distributing earnings to our shareholders. We are incredibly proud of what we achieved in 2022 despite ongoing headwinds, including geopolitical conflict, inflationary pressures, a challenging labor environment and supply chain disruptions, coupled with an accelerated rise in interest rates, Mount Logan saw record revenues from our asset management business and made substantial progress in building our insurance practice, expanding Ability Insurance into a reinsurer of multiyear guaranteed annuities. This helped drive meaningful asset growth and profitability. As mentioned on prior earnings calls, we also continue to evaluate M&A transactions that align with our strategic plan, and we are pleased to announce after year-end, our agreement to acquire Ovation Partners, a specialty finance-focused asset manager with approximately $254 million in assets under management. We see significant additional opportunities available in the marketplace, both organically and inorganically to grow our business and enhance value for our shareholders. Before I speak to our financial results for the year, I wanted to first provide a quick overview of the highlights across our 2 business segments, asset management and insurance. Our Asset Management segment encompasses our retail and institutional targeted businesses. Retail includes our U.S. interval fund known as Alternative Credit Income Fund, or Alt-CIF, our recently launched opportunistic credit interval fund, or OCIF, and our sub-advisory relationship with First Trust Private Credit Fund, which was established in August 2022. The institutional business covers our BDCs and CLOs, which are our permanent and long duration capital. For the year, we generated $7.1 million in asset management and servicing fees on our large and growing asset base. On the retail side, Alt-CIF had a strong year with our sales force raising $59 million in new fund subscriptions through 2022. Outside of Alt-CIF, we launched OCIF in July of 2022, and we've been working to scale the fund since its launch. The fund has performed well since inception, returning 17% through December 31, 2022. We continue to onboard additional distribution partners and scale our sales team and are seeing success from the ability to sell multiple products in our retail channel with Alt-CIF and OCIF. We are also very excited about our new sub-advisory partnership with the First Trust private credit fund. On the institutional side, our business is diversified across a number of BDC and CLO funds, which represents over $1.5 billion of assets and provide a level of predictability in Mount Logan's top line due to the stable nature of fees generated on its permanent and semipermanent capital base. Logan Ridge, one of our 2 BDCs underwent a transformative year and its first fiscal year under Mount Logan Management, our wholly owned investment adviser subsidiary and reported one of its best quarters in its history during the fourth quarter of 2022. Logan Ridge achieved its second consecutive quarter of positive net investment income with the fourth quarter net investment income more than triple the prior quarter, which, in turn, led to the reintroduction of Logan Ridge's quarterly dividend, a huge milestone for the platform. As of year-end, Logan Ridge had an investment asset base of over $200 million. Mount Logan maintains its exposure to its second BDC, Portman Ridge, through its minority interest in Portman Ridge's investment adviser, Sierra Crest. Portman Ridge finished the quarter with approximately $620 million in assets under management and the management contract continues to provide consistent quarterly cash distributions to Mount Logan. Through 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 continue to perform despite operating under difficult market conditions. On the CLO side, AUM for the fourth quarter was $647 million and continues to produce a steady stream of management fee income. In 2023, our revenue share on the CLOs will increase from 30% to 100%, which will drive increased organic top line performance in our asset management business going forward. On the insurance vertical, we continue to progress on the integration and optimization of Ability and are beginning to realize synergies with our asset management business that we envisioned at close. As a reminder, Ability is a Nebraska-based insurer and reinsurer of both long-term care and annuity policies with approximately $885 million of invested assets as of the end of the year. Mount Logan management manages a significant portion of Ability's assets, which continue to grow as we increase our annuity exposure and originate floating rate private credit assets with excess spread at attractive capital charges, which enables us to meet our commitments to our policyholders. Overall, Ability achieved strong insurance core earnings for 2022, increasing $15 million versus fiscal 2021, demonstrating the value of our shift in strategy. We remain focused on improving the portfolio yield through the optimization of the investment holdings, further scaling the annuity business and performing our reinsurance obligations. On the portfolio side, we continue to originate high-quality opportunities and 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 8.5% on December 31, with a fourth quarter annualized statutory portfolio yield reaching 6.8%. On the liability side, we continue to believe our annuity reinsurance business is attractive in the current environment. The annuity policies we reinsure contain surrender charges which protect Ability from earlier-than-expected policyholder withdraws. Additionally, as we continue to reinsure more annuities, Ability's overall liability duration decreases due to the short duration of the annuity products we reinsure relative to that of our long-term care business. We also find that the current cost of annuity liabilities to be attractive given the current asset deployment environment. In regards to growth, we're over halfway to completing a $250 million in MIGA premiums that we've agreed to reinsure, which we signed over 2 contracts in the second and third quarters of 2022. Our reinsurance deals accelerate our transition from our legacy long-term care business increased the predictability of our liabilities and help Ability to transform to a larger insurance solutions platform. During the quarter, we also obtained a $7.5 million loan to support growth and Ability which enabled us to grow investment assets by over $50 million in the fourth quarter. Although we are in the early innings of executing on Ability's long-term strategy, we continue to progress on the above initiatives and our positioning Ability for long-term growth, which will 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 will be driven by the growth strategy outlined earlier on the call. As we discussed in the quarter with many of you, we appreciate the importance of being able to arrive at platform level valuation for our business and wanted to provide our views given the 2 business segments, asset management and insurance. On the asset management side, we view fee-related earnings as the relevant valuation metric for alternative asset managers and are committed to growing this metric prudently. We updated our earnings release to highlight our FRE growth in 2022, which Jason will go through later. On the insurance side, the valuation metric best understood in the market remains book or equity value of the business or assets minus liabilities. Given the positive spread we are earning on our insurance liabilities, we expect our book value to compound over time. We believe some of the parts analysis provides the best -- provides the appropriate credit to each of these core businesses through the application of a multiple to each management FRE, asset management FRE and insurance book value based on peers in the respective markets. This quantitative approach to valuation would imply a significant upside to our share price based on where the market trades today. Before turning the call over to Jason, I did want to take a quick moment to reflect on the progress we've made at Mount Logan as Mount Logan embarks on its fifth year under our management. As of year-end, Mount Logan has $2.6 billion of attributable assets under management, making us amongst the larger publicly traded asset -- alternative asset managers in Canada. Since 2018, we've closed on 6 acquisitions or strategic investments with one additional acquisition announced in January 2023. Each acquisition added a unique angle to the company through product, investor or distribution expansion and helps leverage our fixed cost base. Lastly, since we began managing Mount Logan, we strategically oriented the business towards alternative assets in the credit space managed through permanent and semipermanent vehicles. Market dynamics today enhance our position as banks further retrench for middle market lending while private market fundraising and AUM growth flows. We maintained strong revenue visibility through our closed-end vehicles and are not subject to the same fundraising time lines nor hurdles as other private market-oriented investment managers. Our team is excited about the progress we made at Mount Logan as we move into 2023. We are constantly evaluating ways to grow our business and maximize value across the platform, consistent with our long-term objectives. With that, I'll hand over the call to Jason, who will review the financial results for the quarter and full year.

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 fourth 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 fourth quarter of 2022, we generated $2.7 million of revenue. Breaking down our asset management revenue, our CLOs generated approximately $443,000 in collateral and management fees for the quarter. Net earnings related to OCIF comprised of interest income, net of servicing expense, was approximately $335,000. 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 $386,000 of attributable revenue for the quarter. Excluding gains and losses from investment activities, our asset management revenue increased by 55% quarter-over-quarter due to the growing fee-based revenue streams, primarily driven by opportunistic credit interval funds. 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 $5.9 million for the year ended December 31, 2022, up by 44% year-over-year, primarily driven by increased management and servicing fees. For the Asset Management segment, operating expenses for the quarter ended December 31 were approximately $4.2 million. We incurred $1.2 million in interest and credit facility expenses for the quarter, which mainly relate to our $27.9 million corporate credit facility and $15 million seller note related to Ability. Our expenses increased quarter-over-quarter due to the increased borrowing, the higher market interest rates and increased professional fees incurred in connection with the expansion of the company's business into an asset management and insurance platform. Moving on to our insurance business. We had total revenue this quarter of $23.9 million, which is primarily due to net investment income and unrealized gains on the investment portfolio. Overall, given the current investment portfolio and liability structure at 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 December 31, 2022, our Insurance segment generated $4.9 million of core earnings compared with $7 million in the previous quarter. The decrease in core earnings was driven in part by a reduction in net premiums earned of $5.9 million compared with approximately $9.4 million in the previous quarter. This was offset partially by increased net investment income on the investment portfolio of $1.2 million. For the year ended December 31, 2022, Mount Logan achieved a basic earnings per share of $0.82 and an adjusted basic earnings per share of $0.57. The decrease in earnings per share across basic and adjusted presentation is largely due to investing activities, including the noncash change in insurance contract liabilities and reinsurance assets. As of December 31, 2022, Mount Logan's balance sheet reflected total assets of $1.35 billion, total liabilities of $1.25 billion and shareholders' equity of $102 million. On the asset management side of the balance sheet, there were minimal changes quarter-over-quarter as transactions in this segment were largely ordinary course in nature. Our cash balance decreased by $4.8 million primarily due to the additional investment in opportunistic credit interval fund. Our intangible assets of $21.5 million represents Mount Logan's interest associated with the management contracts of the CLOs and Logan Ridge. At quarter end, the liabilities related to our Asset Management segment predominantly included outstanding debt obligations of $27.9 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, one 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 0.07 per CVR in April. On February 27, 2023, the former manager announced that NECC and 3 other entities indirectly owned and controlled by Allegiance Coal Limited, including the guarantor of NECC's obligations to Cline under secured notes issued by NECC to Cline, which is Cline's primary asset, had filed for Chapter 11 protection on February 21, 2023. On February 28, 2023, the former manager announced that it was taking an 82% write-down in the value of securities and Cline held by its various funds to reflect the increased uncertainty of future cash flows to Cline from the NECC notes. We will evaluate further distributions 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 $885 million in investments. The $253 million of reinsurance assets reflects the estimate of the net claims recoverable viability 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 $826 million, which represents the estimated claims payable to Ability's policyholders before any reinsurance recoveries based on policy data and actuarial assumptions. As mentioned last quarter, based on mortality, morbidity, 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. Overall, our book value increased 6% quarter-over-quarter. We expect to continue to increase book value in our Insurance segment over time. And as Mount Logan management continues to grow its allocation of managing Ability's insurance assets, we expect the combined synergies between asset management and insurance to rewards. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thank you, Jason. In closing, in a period of rising rates and market volatility, we want to ensure our investors our focus remains on monitoring and managing our portfolios and carefully underwriting new investment opportunities. These are key tenets of our strategy and will position Mount Logan to further scale its business as other platforms face credit performance challenges. Additionally, we continue to identify new growth avenues for the business, both in credit as an asset class and through strategic relationships or transactions with other platforms. We have a solid M&A pipeline that we believe can help scale and differentiate Mount Logan. We look forward to updating you on our progress on all fronts, including increasing our fee-related earnings on the asset management side as well as growing Ability's book value through our ongoing business and portfolio optimization. We are already seeing the benefits of the synergies across the asset management and insurance segments and have clear momentum in 2023. We're in a strong position and look forward to generating value and improving liquidity for our shareholders. That concludes our prepared remarks. I will now transition the call to Q&A, if the operator could please coordinate.

[Operator Instructions] Our first question for today comes from Pratik Agarwal from Canaccord.

Just a few for -- so the recent volatility within the U.S. regional bank, just wanted to understand if it impacts any MLC and its operations, just high-level color on that, please.

Yes. So we don't have any direct exposure to any of the institutions in question, including Credit Suisse. So we have no exposure. I think the impact on our business is going to be positive in the sense of balance sheet just got a lot tighter at all the banks and just got more expensive. And so the -- like best case scenario, if there's no other knock-on effects from this will be less credit available for borrowers, and that's obviously a very good environment for us. So obviously, we've seen spread widening over the last 12 months, but we've also -- rates have gone to -- from 0% to 5%. So for a given level of risk, we're earning much higher returns right now.

Got it. Makes sense. And then if there's any update on the M&A strategy? I know you touched upon that the pipeline remains strong. Just additional color on that. And any update on the retail fund launch that Mount Logan was initially planning in 2023?

Yes. So on the M&A pipeline still remains strong. So I would expect another M&A announcement sometime in the middle to -- middle of this year. So we've got 2 or 3 things we're working on that we're very excited about. And obviously, time will tell whether it can get them done. Both synergistic and strategic along the lines of the Ovation deal. In terms of new launches, I would say we launched this OCIF product middle of last year. I would say ramp has been a little slower than we would have hoped, mostly due to plumbing, like getting it on the right platforms and everything else. But we've kind of got a pathway for that to happen now. So we expect that fund to scale pretty materially. We have something like -- we have a pipeline of close to $200 million of new investors for that fund. So it's got a little slower than expected, I would say. So it's not a material contributor to earnings right now. But hopefully, we can obviously raise money for that over the course of this year.

Awesome. Got it. And just the last one. I think currently 38% of Ability invested assets fall under a managed ability portfolio, just wanted to understand as to MLC's, future plans with regards to that? Is Mount Logan planning to increase that over time, just some additional color on that, please.

Yes. So for the new assets we take on now, we basically manage close to 70% of the new assets that come on. And so that percentage will increase over time. A reasonable amount of our assets today are managed by our reinsurance contracts. So when you strip that out, the goal over time is as we grow -- we expect to grow Ability by a couple of hundred million dollars this year. And obviously, that will give us more assets to manage, which will allow us to generate more asset management fees. So we expect the percentage of the Ability assets that we managed to go up, and we expect our earnings and fee-related earnings ability to increase pretty materially over the next 12 to 18 months.