Kestrel Group Ltd (KG) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Maiden Holdings third-quarter 2011 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Noah Fields, Vice President, Investor Relations. Sir, you may begin.

Good morning, and thank you for joining us today for Maiden's third-quarter 2011 earnings conference call. Presenting on the call today, we have Art Raschbaum, Maiden's Chief Executive Officer, along with John Marshaleck, our Chief Financial Officer. Also in attendance is Pat Haveron, Executive Vice President.

Before we begin, I would like to note that any forward-looking statements on this call are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and these forward-looking statements are based on the Company's current expectations and beliefs concerning future developments and the potential effects on the Company. There can be no assurance that the actual developments will be those anticipated by the Company.

Our actual results may differ materially from those projected as a result of significant risks and uncertainties, including nonreceipt of expected payments; changes in interest rates; the effect of the performance of the financial markets on investment income and fair value of investments; the impact of competition and pricing; changes in demand for the Company's products; the effects of general economic conditions and unusual weather-related activity; adverse state and federal legislation and regulations and the regulatory investigations into industry practices; developments relating to existing agreements; heightened competition; changes in pricing environment; and changes in asset valuations.

Of course, the Company undertakes no obligation to publicly update any forward-looking statements except as may be required by law. Some of our discussions about the Company's performance today will include reference to both non-GAAP financial measures and information that could reconcile those measures to GAAP, as well as certain operating metrics, and may be found in our filings with the SEC and in our news release located on Maiden's Investor Relations website.

And with that, I will turn it over to Art.

Thank you, Noah. Good morning, and welcome to our third-quarter earnings call. I'm very pleased to report that we continue to deliver profitable underwriting performance with no adverse impact from catastrophes in the quarter.

Across the reinsurance sector, while perhaps not quite as challenging as the first six months of 2011, the third quarter reflected the continued impact of catastrophe activity, including, of course, Hurricane Irene in the US and the continued development from the cat events of the past year.

For Maiden, a continued, disciplined focus on our highly differentiated strategy of focusing on the non-catastrophe reinsurance needs of regional and specialty insured clients has served us well. Importantly, we continue to strengthen operating earnings and expand our underwriting portfolio.

In the quarter, our strong revenue growth reflects the successful integration of our acquired UK-based international business development platform, along with the continued expansion of existing client relationships, as well as the addition of a number of new client relationships. We also began to see the earnings benefits from the lower cost of funding from our recently completed $107.5 million senior notes debt issuance.

Our operating earnings for the quarter totaled $21.4 million. This represents the best quarter in Maiden's history and compares favorably to the prior year's third-quarter operating earnings of $18 million.

Fully diluted operating earnings per share were $0.29 in the quarter versus $0.25 in the prior year. And notwithstanding the challenges of a very volatile investment market, book value per share stands at $10.63 per share, which remains comfortably above year-end 2010 book value per share of $10.40.

Our annualized operating return on equity for the quarter is 11.1%, while our year-to-date annualized return on equity is 9.2%.

Strong written premiums in the quarter largely reflect the continued significant growth in our diversified and AmTrust business segments. While we initially expected some moderation in the level of written premium growth in this quarter, we continue to experience success in expanding the underwriting portfolio. It is important to note that we've maintained our underwriting discipline approach, and adhere to our risk-adjusted performance targets in acquiring new business.

Written premium for the quarter totaled $428.6 million, and that represents a 56.7% increase over the prior year's written premium of $273.4 million.

In our diversified segment, written premium totaled $188.7 million, an increase of 80.6% from $104.5 million of written premium for the third quarter of 2010.

Our growth is the result of the impact of our international acquisition in late 2010, and, importantly, organic growth from our US operations, reflecting expansion of existing client relationships and the addition of a number of new clients.

You may remember that between 2009 and 2010 we experienced a reduction in written premium for the diversified segment. And that was triggered by a conscious decision to de-emphasize our lower-margin accident and health business at the time, along with the decision by a number of clients to retain more risks.

Now, I'm very pleased to say that our US operation recovered very nicely, benefiting from the expansion of existing client relationships as we were given larger shares of existing programs, and increased demand from new clients in our regional and specialty insurers segment.

We believe that in our target market, companies have begun to react to strength in capital through reinsurance in response to the impact of increased pressures on their own balance sheets. We believe that this trend could well continue for the January 1 renewal season and beyond, as many of our target market companies have experienced significant financial pressures triggered by a large frequency of catastrophe losses in the second and third quarter, along with challenges stemming from reduced investment earnings. We're hopeful that Maiden will benefit from this expected increased demand, which could lead to a very busy January 1 renewal season.

We just completed our visits at the annual conventions of both the National Association of Mutual Insurers, NAMIC, and the Property and Casualty Insurance Association of America, the PCI.

As we met with clients and prospects, the vast majority of discussion centered around their efforts to increase pricing levels. While it is premature to assume that this rate level activity is sustainable, there is clearly an effort on the part of our clients and prospects to ensure that they return to more profitable underwriting levels.

For Maiden, we remain focused, and, we believe, well-positioned to deliver value to our regional and specialty insured clients. As a specialty-oriented company, we continue to believe that we can deliver greater value to our clients by providing for the non-catastrophe reinsurance capital needs with customized solutions.

The balance of the strong written premium growth was largely driven by our AmTrust strategic quota share relationship. Net written premium for the quarter for the AmTrust segment totaled $173.5 million, and that is an increase of 57.3% over the $110.3 million of written premium in the prior-year third quarter.

The growth reflects their success in expanding their position in the US small account commercial lines business and continued growth in their international segment. In addition, as you may remember, we also expanded our relationship in the last quarter to include reinsurance support for their European hospital liability program. Importantly, across the AmTrust platform, they're experiencing significant rate increases, which should have a favorable impact on future performance.

To date, 2011 has been a very successful year for Maiden as we continue to focus on serving the unique needs of our market segment. As we have commented before, we believe that our growth is coming from the right places, as we focus our efforts on the more data-rich, actuarially credible lower-layer reinsurance capital needs of our clients, and focus on the needs of our strategic quota share clients, AmTrust and ACAC.

Through our unique platform, we benefit from significant operating efficiency, which expanded in the quarter; capital efficiency; a truly differentiated approach to serving the needs of our customers; and the added security that we provide our clients with our unique collateral trust product.

We've commented in the past about our ability to more efficiently use our balance sheet. At the current level of writings, we believe that we are optimizing that efficiency while maintaining appropriate capital adequacy.

From an underwriting perspective, our combined ratio for the quarter was 97.4%. That is a reduction from our second-quarter 2011 combined ratio of 99.8% and essentially flat versus the 97% combined ratio in the third quarter of 2010.

Our diversified semi-combined ratio was 95.8% as compared to a combined ratio of 100.3% for the last quarter of 2011 and 95.8% in the prior year. This diversified segment includes our US underwriting subsidiary, Maiden Re, as well as Maiden International Insurance Services, our international reinsurance business development platform.

You may recall that we did experience the impact of the high frequency of US weather-related losses at Maiden Re in the last quarter. This quarter, while the broader industry saw the impact of Hurricane Irene in the US, for Maiden, weather-related losses were well within the anticipated provision for normalized losses.

As we've commented before, Maiden is not a catastrophe-oriented reinsurer. Our exposure to weather and other natural hazard catastrophes comes from the aggregation of property exposures that are embedded in our lower-layer-focused reinsurance programs. We manage that exposure with the use of occurrence limits, careful exposure management, as well as the use of probabilistic models with the objective of mitigating our exposure in extreme 100- and 250-year event catastrophes to currently less than half of expected annual earnings.

We did experience a higher loss ratio from the AmTrust segment. Our combined ratio in the quarter was 97.8% compared to 95.6% in the prior year, and essentially flat versus the last quarter of 2011.

That combined ratio reflects the continued impact of business mix, as well as the conservative booking of our European hospital liability business earned premium. Given the relatively new nature of the business in our portfolio, we chose to utilize an expected loss ratio that is consistent with our overall combined ratio targets for the balance of the AmTrust portfolio.

We are optimistic that that business will develop favorably over time. Ultimately, as the business develops, we will revert to the actual experience on that segment.

In addition, similar to AmTrust's own experience, we've seen an increase in the overall loss ratio across their segments. While profitable, the increased ratio reflects the impact of the current operating environment.

But we are confident that AmTrust's continued success in strengthening pricing should benefit future performance. Importantly, when measured from the inception of our relationship, the AmTrust relationship remains solidly profitable. And, finally, the ACAC quota share met expectations with a combined ratio of 96.8% versus 96.6% in the prior-year third quarter.

On balance, we're very pleased with both business development and underwriting performance in the quarter. We will remain focused on strengthening underwriting performance for the balance of the year.

I would like to turn the discussion over now to John Marshaleck, our Chief Financial Officer, to provide a financial overview of the quarter. John?

Thanks, Art. Good morning. Starting with the third-quarter results, we reported net income of $16 million or $0.22 per diluted share compared with $18.5 million or $0.26 per diluted share in the third quarter of 2010.

Net operating earnings for the third quarter were $21.4 million or $0.29 per diluted share compared with $18 million or $0.25 per diluted share in the comparative quarter in 2010.

Annualized operating return on equity of 11.1% compared favorably to the 9.6% in the third of 2010.

As Art mentioned earlier, we are very pleased that the cat activity was well within our quarterly provision for normalized catastrophe activity that is priced into the business we write.

For the nine months ended September 30, 2011, net income of $11 million compared to $50.7 million in the same period in 2010. Net operating earnings of $52.4 million or $0.72 per diluted share compared to $55.4 million or $0.78 per diluted share in the same period of 2010.

Significant non-operating cat expenses during the nine months of 2011 included charges related to the repurchase of $107.5 million of junior subordinated debt with proceeds from the June 2011 senior notes offering. Year-to-date 2011 results include $15.1 million of junior subordinated debt repurchased expense and $20.3 million of accelerated amortization of subordinated debt discount and issuance costs.

The 2011 results also include $9.5 million in losses related to thunderstorm and tornado activity across the US in the second quarter, net of the Company's quarterly provisions for normalized catastrophe activity, compared to no catastrophe losses in the same period in 2010.

Art provided a thorough overview of the performance of our business segments. I would only add that the growth we are seeing is high-quality business that meets our return criteria.

Turning to investments, for the third quarter of 2011, net investment income increased by $1.2 million or 7.1% to $18.7 million compared to the three months ended September 30, 2010. As of September 30, 2011, weighted average duration of our fixed maturity investment portfolio was 2.78 years, with approximately $76.3 million of net unrealized gains in the portfolio, compared to a duration of 3.8 years and net unrealized gains of $54.6 million in the portfolio as of December 31, 2010.

The decrease in duration is due to the acceleration of actual and expected prepayments of certain of the Company's government-sponsored mortgage-backed securities, largely due to the declining interest rate environment, which has resulted in significant refinancing of residential real estate loans.

The book yield on the fixed income portfolio, excluding cash, is 3.84%. Maiden's investment portfolio does not contain any non-US government or government-related obligations of Italy, Greece, Portugal and Spain.

The fixed-income market was highly volatile during the third quarter of 2011. As a result, we made only a few selected fixed-income investments during the period, which, combined with strong operating cash flow for the quarter of $61.5 million, resulted in higher cash and cash equivalents as of September 30, 2011, as compared to the end of 2010. Total cash on hand, restricted and unrestricted, was $243.1 million as of 9/30/2011 compared to $185.9 million at the end of 2010.

And as we cautiously deploy this cash, we should further strengthen our earnings run rate. Shareholders' equity was $767.2 million at 9/30/2011, an increase of 2.3% compared to December 31, 2010.

Our 9% asset growth this year has been supported by the healthy operating cash flow, as I mentioned, and when combined with our repurchase of the junior subordinated debt earlier this year, we have improved our balance sheet strength and our earnings run rate.

As the premium growth we have experienced in 2011 has earned, we expect the balance sheet to further improve and position us to further support our business model.

I will turn it back over to Art for some closing comments.

Thank you, John. As John has pointed out, we remain focused on ensuring that we maintain our high-quality investment portfolio; that we manage the risks of a volatile investment environment appropriately. Our balance sheet strength remains solid with increased diversity in our underwriting portfolio, growth in more stable lower-volatility lines, a prudent and cautious approach to managing invested assets, and a strong cash position.

As John indicated, we're confident that this proven balance sheet management enables us to support the continuous development of Maiden's underwriting portfolio.

Across Maiden we're deriving significant benefits from the very strategic initiatives that we put into place over the last several years. Importantly, we're maintaining our growth by leveraging our competitive advantages and by maintaining a disciplined approach to underwriting and managing risk.

As I commented earlier, we're cautiously optimistic the primary insurer pricing activity will continue to strengthen in the coming months and quarters. Importantly, we believe that reinsurance demand will likely grow in our regional and specialty company targeted markets.

With growing pressure on investment earnings across the industry, a focus in underwriting will be essential. We believe that this dynamic significantly favors Maiden. As always, we remain focused on delivering significant value to our customers and, of course, increasing value to our shareholders.

Thank you. Noah?

Yes. Mary, could you please open the line for Q&A?

(Operator Instructions). Randy Binner, FBR Capital Markets.

Hey, thank you very much. You know, I just wanted to -- the growth was obviously very strong in the quarter. And the premiums, the surplus, has grown significantly this year. But at the same time, the business mix has changed. So, just was kind of looking for some color on how we should think about the capital support to ongoing growth and how business mix might be impacting that?

Sure. Actually, we kind of said, I think, in the past, not all premium is created equal. And the way we look at our business, different business that we add to the portfolio has different risk characteristics. So, if we bring on, for instance, proportional business, personal auto, capital associated with that is less than writing high-excess liability business or high-excess property business.

As we look at the additions to the portfolio, we're pretty comfortable that those additions have actually improved our diversification across the portfolio, which benefits our stability.

So, as we look at our balance sheet today and we look at the risk within the portfolio, we're pretty comfortable with our position -- in fact, very comfortable with our capital position. And we also think that the balance sheet sets up nicely for future growth in earnings, which will of course stimulate the ability to expand our portfolio over time.

But as it stands right now, we are quite comfortable with our position.

So you could, you could take -- because it seems like, of the variety of reasons you mentioned in the call, AmTrust is growing; the regional and insurers that you focus on are obviously under stress. It seems like the world is going to send you a decent amount of premiums. So, can you take a few more of these kind of big growth quarters -- and I think you are saying yes -- and then still be comfortable on capital?

Well, let's just dissect the growth that we saw this quarter. A big chunk of it is coming from the international business that we acquired last year, so that was sort of set in motion. Going forward, we expect kind of a more normalized growth level from that as well. The other area where we expanded our involvement with our client AmTrust was in their hospital liability. That's not going to be a recurring sort of bump in our revenues.

So things will, I think, stabilize a bit. I don't anticipate the same level of growth rate next year that we have seen this year, at least as it stands today. So we think that, particularly in our diversified segment, which would benefit from any improvement in demand, we think that kind of growth in the balance sheet should allow us to effectively accept that premium without putting undue stress on the balance sheet.

That's perfect. Thanks for the color.

You're welcome, thank you.

(Operator Instructions). Bob Farnam, KBW.

The growth in Europe, was that mostly in the UK, or are there other countries that you are starting to grow? And what is your overall feeling of the European economic situation?

Yes, well, I will start with the first one because it is probably easier than the last one. But the European business, our focus really over this 12 months has been to just kind of bring the business over. And we may have commented in the past that, because of the way that business develops, you may remember, it's a very kind of niche-oriented business that focuses on dominantly reinsurance of automobile insurance that is partnered with manufacturers and the distribution channels. There is a bit of a longer gestation period of development of new business.

So, as we look at this year, the growth is really just porting over that portfolio to Maiden. And the characteristics of that business, about half of the auto business written emanates from Germany. And then, we see a mix from other elements of smaller countries. We do have some business in the UK. We do have some business in Italy, Sweden, a couple of other countries in Europe.

Okay.

Now, the second part of the question, I think John mentioned, clearly, from an investment portfolio standpoint, we're trying to focus on safety. So, in terms of the balance sheet in Europe, we believe that we are fairly nicely insulated from some of the events there.

As far as sort of the operating environment from the standpoint of the insurance industry, obviously I think there's the risk of pressure on balance sheets there, depending on the relative level of sovereign debt exposures that exist in many of those countries.

So, my general view is that as we look to expand, we're going to be very cautious about the local market conditions and how those influence loss cost. But as we're seeing the business perform today, we're really not seeing any adverse effect on loss cost trend. Importantly, most of the business is Northern European business.

Right. Okay, thanks.

You're welcome.

And the second question, any reserve movements, positive or negative, in any lines of business?

We did have approximately $5 million of reserve movement, favorable reserve movement, from old years now. When you look at our Q which we file, there will be some amortization of the deferred gain on the reinsurance, the loss portfolios that we took over, and that was approximately $12 million. Some of that was used to offset other changes within old underwriting years. But there was about a $5 million change for the current year.

Right, okay. Thank you.

Ryan Byrnes, Macquarie.

Hi, good morning, guys. I was just wondering, just to drill down in the growth of the US regional business, I just wanted to see, I guess to drill down to figure out what lines you guys are increasing. Are they new lines; are they existing lines? Just want to see what types of business you're adding in the US regional business. Thank you.

Sure, absolutely. You know, I think our US business has been a pretty solid, consistent business in terms of portfolio mix and the like. But we see growth in personal auto, and that has been a big part of our growth in the US throughout 2011. And I think we've commented before that we kind of like the pricing environment there. We're definitely seeing companies taking rate action as necessary.

And we've seen commercial auto growth as well as your sort of general commercial multiperil. But, generally, the traditional lines that are underwritten by our regional company clients, which are the more traditional lines of business such as personal and light commercial, we've not expanded into new or more volatile lines of business. We tend to remain very, very focused and disciplined in the kind of business we write and support.

So if I would say there was any dominant component of that growth, probably auto makes up a big chunk of that.

Okay, great. And then, I'm just trying to figure out, is there any sort of -- I guess back to the premium to equity issue, is there any, I guess, constraint? Is there some ratio that you view as upper bound that you don't want to get close to? I'm just trying to figure out for my model going forward, I guess, how to model the growth in the NPW and what the overall constraint would be.

The constraint, it's hard to put a number on the constraint because it really is a function of risk-based capital. So it's how the portfolio kind of aggregates the changes in the risk profile.

And as we see the business today, again, writing proportional business generates less capital than writing excess business, and particularly high-excess business. Writing more traditional stable lines like personal auto requires less capital than writing more volatile lines like general liability or property and [the loan].

So it's a hard question to answer with a broad-line statistic, other than to say that we watch capital carefully. Capital strength is a very important part of our business model. We're committed to provide our clients strong capital position and strong capital support, and we reinforce that with collateral support as well.

So, as we look at our business, if the growth comes similar to the growth that's come in the portfolio today, we're pretty comfortable with our ability to continue to build the portfolio. And as I mentioned earlier, a lot of the growth we saw this year, we wouldn't necessarily expect to see repeat of that. We're not going to -- the international business isn't going to double next year. We've expanded our AmTrust relationship with the hospital liability. But we don't see that business doubling next year. I think a lot of what we're seeing this year, a portion of it is certainly from some of the initiatives that we launched last year.

Okay, great. And then just lastly, I know you touched on it earlier, but with the investment portfolio, I just wanted to get a -- because obviously you guys are writing in Europe in terms of your sovereign exposure to some of I guess the big countries as well as maybe if you owe any corporate debt in the financials in those, I guess, troubled countries?

Yes, we do not hold any debt in the companies. We mentioned the companies that have issued in Greece, Portugal, Spain and Italy. The debt that we do hold there is really supporting our liabilities in the countries where we are writing. And most of that, as Art mentioned, is in Germany.

Okay, great. Thanks, guys.

Thank you. I would now like to turn the conference back over to the speakers for any additional remarks.

Thanks to all for your interest in Maiden. We look forward to speaking with you in the future. Have a great day.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect, and have a wonderful day.