Mount Logan Capital Inc. (MLCI) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Mount Logan Capital's First Quarter 2023 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, 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 begin.

Thank you, and good morning, everyone. We appreciate you joining us today for our first quarter 2023 results call. During the call, we will refer to information provided in the first quarter 2023 press release, MD&A and consolidated financial statements, all of which were released on Thursday evening and are available on our website and SEDAR. Joining me this morning to discuss our financial results and outlook for our business is our Chief Financial Officer, Jason Roos; and our President, Henry Wang. As a reminder, all references to dollar amounts on this call are in U.S. dollars, unless otherwise stated. Overall, the first quarter of 2023 was a transformative quarter for our business. Our team put in a tremendous amount of effort achieving several notable highlights, including the successful transition to IFRS 17, progression towards the final close of our previously announced transaction of Ovation, including hiring of 16 of the former Ovation employees post quarter end. And the achievement of a record MYGA volumes in our insurance vertical, which is driving significant growth in assets. We're also pleased to announce that we will be maintaining our dividend for the quarter, which will pay CAD 0.02 per share distribution for shareholders of record as of May 18, which will mark our 15th consecutive quarter of distributing earnings to our shareholders. Consistent with the softer market tone witnessed through 2022, macro headwinds persisted during the first quarter of 2023, primarily attributable to the bank failures of Silicon Valley Bank, Signature Bank and First Republic Bank during March and April. Our business and portfolios were well insulated with minimal exposure to the failed banks. Our managed funds capitalized on the opportunity to deploy capital into investments with attractive risk-adjusted returns following the bouts of volatility. As mentioned on prior earnings calls, the IFRS transformation we underwent in the first part of 2023 was a huge lift by all parties involved. We do not want to call out the quarter-over-quarter changes in our reported financials attributable to the IFRS 17 conversion as well as the elevated costs associated with the implementation, coupled with the fees and expenses from recent M&A activity. IFRS 17 innovation, while important milestones for our business, create short-term noise in our reported numbers, and we plan to follow up with a supplemental package for investors to provide additional context on the business and financial performance. Before I speak to our financial results for the year, I will provide a quick overview of the business highlights across our 2 key business segments: Asset Management and Insurance. Our Asset Management segment encompasses our retail and institutional targeted businesses. The retail segment represents our U.S. interval fund known as Alternative Credit Income Fund, or Alt-CIF; the Opportunistic Credit Interval Fund, or OCIF; and our sub-advisory relationship with First Trust Private Credit Fund. The institutional business covers our BDCs and CLOs, which are our permanent and longer duration capital. For the quarter, we generated $1.6 million in management and servicing fees on our large and growing asset base. We note this figure excludes $823,000 of management fees generated from managing a portion of Ability's assets. On the retail side, Alt-CIF continued to see new fund subscriptions outpace redemptions. On OCIF, the fund has performed exceptionally well since inception, returning over 21% through March 31, 2023, and we are close to onboarding with additional distribution partners, which will accelerate its growth. Additionally, AUM through our sub-advisory relationship with First Trust Private Credit Fund grew 92% quarter-over-quarter and we expect it to continue to trend upwards over the next year. On the institutional side, our BDC and CLO funds today represent over $1.5 billion of assets and provide predictability in Mount Logan's top line due to the stable nature of the fees generated on its permanent and semipermanent capital base. Logan Ridge achieved its third consecutive quarter of positive net investment income with first quarter net investment income up 65% versus the prior quarter, which supported an increase to Logan Ridge's quarterly dividend, another significant milestone for the platform following the reintroduction of its dividend one quarter prior. As of quarter end, Logan Ridge had a total asset base of $216 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 $594 million in total assets 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 volatile market conditions. On the CLO side, AUM for the fourth quarter was $650 million and continues to produce a steady stream of management fee income. By the end of 2023, our revenue share on the CLOs will increase from 30% to 100%, which will increase organic top line performance in our Asset Management business, resulting in an approximately $1 million increase in cash flow on a run rate basis. From the Insurance side, we continue to progress the integration and optimization of Ability and are realizing the synergies with our Asset Management business, which we envisioned at close. As a reminder, Ability is a Nebraska-based insurer and reinsurer of both long-term care and annuity policies with an approximately $905 million of invested assets as of the end of the quarter. 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 enable us to meet our commitments to our policyholders. Insurance remains a highly strategic focus for our team, and we remain focused on continuing to improve the portfolio yield through the optimization of the investment holdings, further scaling the annuity business and performing on our reinsurance obligations. We've seen our efforts materialize in the first quarter annualized portfolio yield, reaching 9%, which is up 1.27% when compared to the fourth quarter of 2022 and up 4% when compared to the first quarter of 2022. On the liability side, we 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. As we reinsure more annuities, Ability's overall liability duration decreases due to the shorter duration of the annuity products we reinsure relative to that of our long-term care business. We also find the current cost of annuity to be attractive given the current asset deployment environment and diversifies our underwriting risk on the liability side of the Ability. In regards to growth, we're 2/3 of the way towards completing the $250 million in MYGA premiums that we've agreed to reinsure, which we signed over 2 contracts in the second and third quarter of 2022. Our reinsurance deals accelerate our transition from our legacy long-term care business, increased predictability of our liabilities and help Ability to transform into a larger insurance solutions platform. With respect to M&A opportunities, our pipeline remains robust. We expect to announce more strategic activity in the second half of the year, which provides further scale to our platform. As mentioned on prior calls, we appreciate the importance of being able to arrive at platform level valuations of our business and provide additional disclosure in coming weeks with respect to our 2 lines of business, Asset Management and Insurance. We continue to believe that some of the parts analysis on our business imply a significant upside to our share price based on where the market trades today, and we look forward to providing you additional clarity in coming weeks. Before I turn the call over to Jason Roos, I did want to take a moment to thank our team for their commitment to Mount Logan and helping us push forward on the various initiatives we have in fly. We are energized by the opportunity set, and we will continue to evaluate ways to grow our business and maximize value across the platform, consistent with our long-term objectives. With that, I'll hand the call over to Jason, who will review the financial results for the quarter.

Thanks, Ted. Good morning, everyone. I will now summarize our key highlights for the first quarter 2023. As a reminder, all figures referenced on today's call will be in U.S. dollars, Mount Logan's functional and presentation currency. Before discussing the performance of our 2 businesses, Asset Management and Insurance, I would like to mention that we implemented a significant change to our financial statement presentation for our Insurance segment this quarter relating to the adoption of the new Insurance Contracts Accounting Standard, IFRS 17. We applied the standard retrospectively, thus all figures, where appropriate, will reflect the adoption of this standard. For our Asset Management segment in the first quarter of 2023, we generated $1.8 million of revenue. Our CLOs generated approximately $283,000 in collateral and management fees for the quarter. The net earnings related to OCIF comprised of interest income, net of servicing expense, was approximately $156,000. With regard to our BDCs, Logan Ridge generated approximately $930,000 in management fees. And through our minority interest in Sierra Crest, the company recognized over $467,000 of attributable revenue for the quarter. Excluding gains and losses from investment activities, our Asset Management revenue decreased by 28% quarter-over-quarter due to the normalization of our CLO income and a reduction in the net economics related to our servicing agreement with Sierra Crest. For the Asset Management segment on the expense side for the quarter ended March 31, we incurred approximately $5.7 million in operating expenses. For the quarter ended March 31, Mount Logan incurred $1.3 million in interest and credit facility expenses related primarily to our -- incurred $1.3 million in interest and credit facility expenses, which primarily relates to our $27.5 million corporate credit facility and $15 million seller note related to Ability. Our interest expense increased quarter-over-quarter due to higher market interest rates, and we had increased professional fees incurred in connection with the implementation of IFRS 17 and the continued 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 $10.2 million, which is net of insurance service expenses and net expenses from reinsurance contracts held. Revenue quarter-over-quarter for the insurance business has fluctuated significantly due to the adoption of IFRS 17. Excluding the impact of the adoption of IFRS 17, our Insurance business net investment income and unrealized gains on the investment portfolio were the significant drivers for positive performance this quarter. Overall, given the current investment portfolio and liability structure at Ability, we expect that rising interest rates will continue to have a long-term benefit to Ability's capacity to generate investment yield in the form of net investment income. Our Insurance business reported total expenses of $35.5 million during this quarter. The increase in expenses is largely due to the lower discount rate being applied to our insurance liabilities as part of the adoption of IFRS 17, which has accelerated expense recognition for contracts deemed to the owners, which both our long-term care and multi-guaranteed annuity contracts are considered. For the quarter ended March 31, 2023, Mount Logan reported a basic loss per share of $1.33 and an adjusted basic loss per share of $1.30. The decrease in earnings per share across basic and adjusted presentation is largely due to the adoption of IFRS 17. As of March 31, 2023, Mount Logan's balance sheet reflected total assets of $1.57 billion, total liabilities of $1.55 billion and shareholders' equity of $21.4 million. The significant decline in shareholders' equity from previously reported December 31, 2022, figures is due to the cumulative impact of the adoption of IFRS 17, which had a day 1 adoption impact of $80.2 million to opening shareholders' equity. On the Asset Management side of the balance sheet, there were nominal changes quarter-over-quarter, with one exception pertaining to the recognition of a $2.5 million unrealized loss this quarter relating to the company's holdings and the client corporate debt. The unrealized loss is driven by uncertainty surrounding the outcome of the bankruptcy process. We continue to actively monitor this investment. These losses were partially offset by investment and OCIF, which saw its fair value rise 16% since the initial seed investment due to capital appreciation in the underlying portfolio. At quarter end, the liabilities related to our Asset Management segment predominantly included outstanding debt obligations of $27.5 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, which shown net of deferred financing costs. On the Insurance side of the balance sheet, total assets of $1.5 billion represented an increase of $37.4 million, or 2.5% from December 31, 2022. Cash and cash equivalents decreased by $9.7 million as a result of net deployment during the first quarter of 2023. Investments in financial assets increased by $20.2 million, reflecting the growth of the Insurance segment. Total asset base, which was driven by the accrued interest. Reinsurance contract assets increased by $22.5 million compared to December 31, 2022, and related to our arrangements with third-party reinsurance providers. The increase was primarily due to the impact of finance income required to reflect the time value of reinsurance contract assets under IFRS 17. Our Insurance segment had total liabilities of $1.5 billion, representing an increase of $63.4 million or 4.4% from December 30, 2022. Insurance contract liabilities represent liabilities calculated under IFRS 17 related to long-term care insurance and the multiyear guaranteed Annuity business. Insurance contract liabilities increased by 50.5% compared to December 31, 2022, primarily due to the impact of finance expenses required to reflect the time value of the insurance contract liabilities under IFRS 17. Accrued expenses and other liabilities primarily includes payables for investments purchased and other accrued expenses. Accrued expenses and other liabilities decreased by $15.2 million, primarily due to a decrease in payables for investments purchased. The company remains adequately capitalized for the near future, and we expect to grow both value in our Insurance segment over time, building upon combined synergies between our Asset Management and Insurance segments. I will now turn the call back to Ted Goldthorpe for some closing remarks.

Thank you, Jason. In closing, we remain focused on identifying and executing new growth avenues to create value for our business and our shareholders, both in credit as an asset class and through strategic relationships or transactions with other platforms. We look forward to updating you on the progress on all fronts. We see a clear pathway for growth through 2023 and are in a strong position to generate value for our shareholders. This concludes our prepared remarks. We'd now like to transition the call to a Q&A session, if the operator can please coordinate.

[Operator Instructions] Our first question comes from Scott Chan of Canaccord Genuity.

Maybe I'll start with Jason just on Asset Management. Jason, you talked about the revenue, I think it declined 28% quarter-over-quarter and you called out CLOs and Sierra Crest. I'm just trying to figure out maybe what kind of caused that sequential decline? And like is that impacts the run rate going forward for this year on revenue.

Yes, sure. So the CLOs had a little bit outsized quarter last quarter. So I would say that CLO income has normalized this quarter. And then as -- due to some investments that we've made within the sales and marketing aspect of all SIP, that's led to some costs offsetting some of the revenue within the equity investment of Sierra Crest. We would expect that to kind of maintaining normal. Yes, I would say it will pop up a little bit, I would say, another roughly $50,000 next quarter. But I would say that the run rate is as expected right now. Another factor that was reflected in last quarter's management fees is some of the OCIF investment or equity investment and that has kind of normalized this quarter from where it was last quarter. And then some of the revenue on other Asset Management streams like the First Trust Sub-advisory agreement increased quarter-over-quarter. So that's a positive trend I just see in that number, but largely where we ended up this quarter would be roughly where I would expect to be next quarter. The other thing to call out is the interest income line also represents fee stream revenue that's reflected in the form of an interest income line because of our debt agreement between Mount Logan Capital and Sierra Trust. So you should really think about that interest line as a management fee stream as well.

So I think we're going to provide our additional disclosure. I think what we'll show you is your fee income continues to grow. And the volatility is much more around investment income. And so we will -- like I think when people look at our stock, they really are looking for guidance around FRE. And some of the volatility you're seeing in that is investment income. So what we'll do for our investors is we're going to provide some additional disclosure just because to your point, it looks a little funny when you look at our quarter-over-quarter trends.

And maybe to tie that in, Ted, on the FRE for Asset Management is $1.4 million down from last year. And expenses were really up in that segment. It looks like it was G&A. So like is FRE in terms of a target this year, it seems like it's tracking below last year and based on Jason's comments on revenue, is that kind of fair?

Well, I'll let Jason address it a little bit, but there are a lot of onetime items in that expense. So those are not -- that increase in expenses, it's not a recurring number. And again, a lot of accounting fees to transition to IFRS 17 are in that number, which is really a onetime item. And so again, we have to disclose things on an IFRS basis. But again, we should break out our investor supplement onetime items versus recurring expenses. So I don't think you could take our expense though today to be the run rate. We have made some increased investments in our retail business. So we brought on some additional salespeople and stuff, which are -- the payback for them comes later. But by and large, a lot of the increase in expenses is really onetime in nature.

Yes. Just to layer on to that. So the expense line in that G&A line has about roughly $1.3 million of 1x largely related to the implementation of IFRS 17, which is around its course at this point. And then you have some of the additional investments in the retail platform that would look to come down over time, but that's another, call it, $400,000 related to that.