Argo Group International Holdings Ltd (ARGO) 2013 Q2 法說會逐字稿

Welcome to the Argo Group 2013 second-quarter earnings call. My name is Adrian and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.

I will now turn the call over to Susan Spivak-Bernstein, Senior Vice President, Investor Relations. Susan Spivak-Bernstein, you may begin.

Thank you and good morning. Welcome to Argo Group's conference call for the second quarter of 2013. Last night, we issued a press release on earnings, which is available in the Investor section of our website at www.Argolimited.com.

With me on today's call is Mark Watson, Chief Executive Officer, and Jay Bullock, Chief Financial Officer. We are pleased to review the Company's results for the quarter, as well as provide you with management's perspective on the business.

As the operator mentioned, this conference call is being recorded. Following managements' opening remarks, you will receive instructions on how to queue in to ask a question.

As a result of this conference call, Argo Group management may make comments that reflect their intentions, beliefs and expectations for the future. Such forward-looking statements are qualified by the inherent risks and uncertainties surrounding future expectations generally and may materially differ from actual future results involving any one or more of such statements. Argo Group undertakes no obligation to publicly update forward-looking statements as a result of events or developments subsequent to this conference call.

For a more detailed discussion of such risks and uncertainties, please see Argo Group's filings with the SEC.

With that I am pleased to turn the call over to Mark Watson, Chief Executive Officer of Argo Group.

Thank you, Susan. Good morning, everyone, and welcome to Argo Group's second-quarter earnings conference call. I will briefly share my thoughts regarding this quarter's highlights, after which Jay Bullock, our CFO, will add more detail to the quarter's financial results.

Overall, we are pleased to report our results for the second quarter, having generated $31.7 million or $1.13 per diluted share of net income, which is up from $24 million or $0.84 per diluted share in the second quarter of 2012. Our second quarter for 2013 operating earnings were $0.74 per share compared to $0.50 in the comparable quarter in 2012, or an increase of almost 50%.

During the second quarter, the capital markets suffered as a result of interest rate volatility and, like everyone else, our investment portfolio was affected by the significant rise in rates, widening of credit spreads and the June decline in equity values. From year-end, the decline in our unrealized gain position was approximately $80 million on a pretax basis.

As a result, we ended the quarter with diluted book value per share of $55.73, which was still up modestly from $55.22 at year-end December 31, 2012.

Fortunately, with the market recovery in the month of July, we regained approximately 50% of the second-quarter decline. This is mainly from the diversity in asset classes added to our portfolio over the past few years.

That said, the decline in rates over the past several quarters and changes we have made in asset class selection have impacted our net investment income and will likely continue to do so for the next few quarters. Our objective is to create long-term value for our shareholders, and we believe the decisions we have made will do just that. So in the short run, our investment income will likely decline as the duration of our bond portfolio shortens even more than in the past.

We have maintained a measured pace of return of capital to shareholders in the quarter. While our stock price has moved up quite a bit this year, we continue to think our franchise is undervalued and still view share repurchases at a discount to book value as a great investment.

In the first six months of this year, we have repurchased approximately 750,000 of our shares, or 3% of our 2012 year-end share base. In the second quarter, we repurchased $17.8 million or 427,751 shares at an average price of $41.58.

Our dividend remained consistent with the previous quarter at $0.15 per share on a slightly larger number of shares for a total dividend payment in the quarter of just over $4 million.

Turning now to our underwriting business, in the second quarter, we produced consolidated gross written premium of approximately $543 million, an increase of 14.3% from the second quarter of last year. All of our segments contributed to the growth this quarter with the exception of our Commercial Specialty business, but as I forecasted on our last call, that was as expected.

In terms of market conditions, we continue to experience rate improvement consistent with the first quarter of 2013 and within our expectations for each of our businesses, with the sole exception of our property catastrophe business, where we have seen slight rate decreases.

While signs of increased competition are becoming evident in the marketplace, our established positions in our selected areas of focus have allowed us to continue to push for rate increases. As we noted last quarter, in businesses where we identified the greatest need for rate improvement, we are still achieving our plans.

Unlike the first quarter, the second quarter of this year presented a higher frequency of small to midsize catastrophe and weather events, the effects of which were experienced across the market. Despite this higher activity, our combined ratio improved just over four points year-over-year. We continue to benefit from favorable reserve development on prior years, and we see the benefit of our past and ongoing repositioning efforts in certain businesses.

While we had our share of large losses in the quarter and were impacted by some of the catastrophe events, the incidence of loss to us is reduced relative to a similar set of events two years ago. A good example of this would be the European floods, the impact of which was approximately $4 million to us. If we had had this happen a couple of years ago, before the re-underwriting actions we have taken, we would have seen a much larger loss.

As we've said in past quarters, our expense ratio remains higher than is acceptable to us. It is, however, a reflection of our long-term investments in the business and we expect to see continued quarter-over-quarter improvement as our initiatives take hold and our recent growth begins to flow through our results.

Let me briefly comment on each of our operating segments before turning the call over to Jay to discuss our financial results in more detail.

Our Excess and Surplus Lines business grew just over 22% in the second quarter. We continued to build on the positive momentum from the first quarter and last year, driven by continued improvement in rates, strong submission activity and good growth in new business. We are particularly pleased that much of the growth is in our most profitable segments. Our practice of reserving prudently in current accident years has been most pronounced in this segment, where, as in prior quarters, we have benefited from positive prior-year development.

In Commercial Specialty, as expected, we saw a decline in gross written premium, which is a direct result of our strategy of removing underperforming accounts. The decline was partially offset by rate increases and modest growth in other business units.

I have to say I feel very positive about the progress we are making year to date, as we are achieving rate increases in excess of our plan, at least at the moment, and I want to thank everyone who has been working on the implementation of this turnaround over the past 12 months. You will recall that we had a fair amount of negative reserve development in this quarter a year ago, and fortunately, that hasn't happened this year.

Our International Specialty segment achieved an increase of 14% in gross written premium, benefiting from growth in all of our business lines. Notwithstanding the market challenges in the Property Catastrophe business I mentioned earlier, we actually grew premium modestly. The buildout of our Brazilian operations is moving along as planned as well. And market conditions continue to improve in small increments in our excess casualty and professional liability businesses here in Bermuda.

Fortunately, our margins -- and I should also say that our margins in these businesses remain good.

Rounding out our segment discussion is our Lloyd's Syndicate 1200, which had another good quarter. Gross written premium grew over 20% in the quarter, benefiting from increased writings in our property book, as well as stronger-than-expected additional reported premium from recent years of account on binding authorities in both small account property and liability units.

Our Specialty business was down in the quarter within the Syndicate, as we exited certain geographies in the energy sector due to declining rates, which I am pleased we did.

In summary, the results for the first six months of the year are an improvement from a year ago and certainly two years ago. We continue to focus on growing where we can in an intelligent manner, improving our underwriting margins, focusing on expense management and producing consistent results across our business units.

We will continue to invest in our stock and return capital to shareholders, weighed carefully against the risk-adjusted returns of other capital uses.

With the investments we have made in our people, systems and processes, 2013 is shaping up to be a pivotal year for Argo and I'm optimistic about our long-term outlook. With that, I will turn the call over to our CFO, Jay Bullock.

Thanks, Mark, and good morning, everyone. I will take everyone quickly through some additional detail on the financials and then open it up to Q&A.

As Mark has already been through growth by segment, I will simply point out that the variance in growth rates in total for gross written, net written and earned premium is largely a function of a change in the timing and composition of one of our larger reinsurance programs.

Overall, our underwriting margins for the business continued to improve. Inclusive of cat losses and a higher than normal incidence of large losses, our accident year loss ratio improved by almost 200 basis points over the first six months of 2012. These improvements are primarily due to rate and underwriting initiatives.

At the same time, our expense ratio improved by almost 100 basis points over the same six-month period in 2012, and by 200 basis points when you strip out the effect of the additional equity compensation expense incurred as a result of the increase in our stock price during the first six months of the year. Not a bad improvement, but not where we want to be yet.

Away from the current accident year, we experienced favorable reserve development in each segment. In E&S, positive development of 9.2 was primarily -- was $9.2 million and was primarily from accident years 2008 and prior, with smaller amounts coming out of 2009 and 2010.

In Commercial Specialty, positive development totaled $1 million, which was the net of positive results in Rockwood and Surety, offset by small movements in Argo Insurance and Trident.

In International Specialty, the result was positive $300,000 and the net effect of small, favorable movements in liability lines, offset by small changes in short-tail lines.

And finally, in Syndicate 1200, the positive result of $1.3 million was the net of small positive movements in property, offset by small negative movements in liability.

In the quarter, losses from cats totaled $9.7 million, coming, as Mark mentioned, from the European floods and US storms, and were largely in line with our expectations.

The only other thing to mention on the income statement was the effective tax rate. For the quarter, the rate was slightly higher than expected given the larger proportionate share of income generated in taxable jurisdictions. For the first six months, the effective tax rate was effectively the same as our expected tax rate of approximately 20%.

Turning to investments, the overall size of the investment portfolio including cash declined approximately $200 million through the first six months of the year, reflecting the decline in asset values from the market movements in June that Mark referenced and from the transfer of approximately $100 million in assets related to the Whole Account quota share transaction for 2009 and prior and the Syndicate we talked about at year-end.

There remains approximately $100 million of additional assets yet to be transferred related to that transaction.

We would note again that any associated investment income, including the income from assets held on our balance sheet, goes to the benefit of our counterparty.

The impact of the transaction combined with continued lower investment yields, reallocation of the portfolio to certain strategies targeted towards total return rather than income, and modest shifts in portfolio duration resulted in the decline in net investment income this quarter versus the same period last year.

The book yield on the fixed income portfolio was 3.2% this quarter compared to 3.4% in the first quarter of 2013 and down from 3.6% from the second quarter last year. We recognized pretax realized gains of $11.5 million. Included in realized gains was approximately $6.5 million in gains from our equity strategies as we took the opportunity to reduce positions slightly during the market's strong first-half performance. As well, gains included approximately $3.4 million from small mandates we have made in the past 24 months that would have historically generated net investment income, but because of the structure of the investment, are accounted for in realized gains and losses.

We ended the quarter with a pretax unrealized gain position on the portfolio of $225 million at quarter-end, down from $305 million at year-end.

As mentioned, July was a strong month and a meaningful portion of that decline has been recovered.

That said, the duration of our bond portfolio is designed to support our liabilities, giving us the ability to hold fixed income investments to maturity. At June 30, while the spread of duration across the portfolio was tightened a bit, the overall duration remained effectively unchanged. And the average credit rating on our fixed income portfolio was AA-minus.

Our equity position at June 30 was approximately $1.5 billion and our total capital approximately $1.9 billion. Both our financial and operating leverage remain modest, which provides us the flexibility to respond to market opportunities.

We have returned $22 million to shareholders in the form of dividends and share repurchases in the quarter and have continued to participate in the market post-quarter-end through a 10b5 program, repurchasing approximately another 120,000 shares for $5.5 million. As always, we evaluate all alternatives to deploy our capital and continue to buy back stock -- to buy back our shares as warranted by the availability of competing investments relative to the compelling valuation in our stock.

Operator, that concludes our prepared remarks. We are now ready to take questions.

(Operator Instructions) Amit Kumar, Macquarie Capital.

Thanks. It's Kumar from Macquarie Capital. Congrats on the quarter. Just a few quick questions. Maybe starting with the E&S line, can you talk a little bit more about, I guess, the increased submissions and how do you feel about the quality of these submissions?

I think we are seeing more submission activity for a number of reasons. I will focus on two.

One, I think more business is flowing back into the non-admitted marketplace. And second, I think that we are doing a better job of executing, meaning I think we are doing a better job of working with our distribution partners and getting out and making sure that we are meeting their needs and they understand the products that we have available to them. So I think working harder is generating more opportunity.

Okay. So there is nothing specific going on in a specific subsegment which is generating; it is just a broader trend?

Yes - no, I think that is across the board within our business. It is not coming from one part of E&S.

Okay, that is helpful. The other question is going back to the opening remarks, regarding, I guess, the discussion on the commercial side, regarding the underperforming accounts, the retooling of the book. Can you sort of expand on that and how should we think about that going forward from here?

So let's go back and think about the last year. It was on this call a year ago that we talked about the significant adverse development that we recorded was over $10 million. And of course, we didn't see that this quarter.

We spent -- as we have done with other portfolios which we have talked about on various calls, we spent a lot of time going back and culling and getting back to really more of our core business for that underwriting tool. We have now been at it for about a year in one portfolio and probably pretty close to that in the other. So I think a lot of the hard work has really been done, particularly as of the first of July.

Recall that that is a really big date for renewing much of our public entity business. I don't mean to suggest that we don't need to continue working to optimize our portfolios and how we interact with our distribution partners, but I am really pleased with how hard everybody has been working and I think that because -- I think the fact that we haven't seen a lot of additional negative reserve development speaks well for getting to it soon. And the fact that our premium didn't decline more than it did I think is a good thing as well.

It is possible, and we should plan, for the top line in Commercial Specialty to be lower for the remainder of this year as compared to 2012. I think it is reasonable to think that in 2014 it will flatten out relative to 2013.

Got it. I guess the final question, and I will stop here, is in the opening comments regarding buyback, you mentioned the stock price -- the price of (inaudible). And I know that you've chatted about this in the past few quarters. Based on your business mix, would you slow down during the hurricane season or the trend line should generally continue?

Well, as a practical matter, I think we all tend to slow down a bit during the hurricane season. Having said that, as Jay pointed out in his remarks a minute ago, we are in the hurricane season now and we still have been buying back a modest amount of stock. So we have been a buyer in the market for quite a while, and I suspect we will stay in the market in some way from now until the end of the year.

And how do you think about buyback? Is that buyback plus dividend equal to sort of net income kind of thought process? I'm trying to recall what we have talked about in the past.

I know that a lot of companies think about it in a formulaic manner. We think about it differently, and perhaps it is just worth repeating.

We first use capital to support our balance sheet and the risk that we have on it today. The second use of capital is to support our organic growth and really adjacency growth that is very core to our business and the business that we are writing today.

Third, depending upon where our share price is, I have either put capital repatriation next or new business opportunity beyond what we are doing today. And in the last few years, I have focused more on capital repatriation. When our stock was trading at $0.50 on the dollar, it was hard to imagine a better use for what we thought was excess capital than buying back our stock.

As our share price comes up, then we may look at other opportunities on a risk-adjusted basis. But as you look at what we have done over the last couple of years, we have clearly still been very focused on buying back our stock relative to making other investments, notwithstanding our share price coming up.

So we are looking at how we can best invest that capital, and it is not necessarily just a function of repatriating earnings -- repatriating capital relative to earnings. We don't think about it that way. We think about how we can best use our capital.

Got it. Okay, that is all I have for now. Thanks for the answers.

(Operator Instructions) John Thomas, William Blair.

Hi. Why did the expense ratio decline so much in Syndicate 1200 for the first half of 2013 relative to 2012?

Earned premium grew substantially year-over-year, from about $80 million to $107 million.

And that is just for the quarter.

Right.

(inaudible) first six months.

It was $151 million versus $198 million. So it is --

Substantially better leverage.

Right. The denominator went up faster than the numerator.

And as successive years have progressed as well, that mix of business is changing a bit there, since the acquisition cost is slowly working its way down. It won't change dramatically, but there is a modest impact for that as well.

Correct.

Okay. And then International Specialty, if you could comment on the growth that you are seeing there and what lines you are expanding in.

Well, as I mentioned in my remarks, we are seeing a modest amount of growth across everything within International Specialty, whether it is property cat, excess casualty, excess professional liability. The piece that is growing the most on a percentage basis would be Brazil, but that is just because it is coming off a smaller base.

All right, thanks.

We have no further questions.

I would like to thank everyone for dialing in this morning. We look forward to talking to you again at the end of the third quarter, and hopefully, we will be able to continue talking about continued progress in running our Company.

I would like to thank everyone at our Company for working hard over the last year; it is starting to show in the financial results. And we will talk to you next quarter. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect.