Kestrel Group Ltd (KG) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Maiden Holdings third-quarter 2014 earnings conference call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to our host for today's call, Mr. Noah Fields, VP of Investor Relations. You may begin.

Good morning and thank you for joining us today for Maiden's third-quarter 2014 earnings conference call. Presenting on the call today we have Art Raschbaum, Maiden's Chief Executive Officer, along with Karen Schmitt, our Chief Financial Officer. Also in attendance today are John Marshaleck, Chief Operating Officer, and Pat Haveron, President of Maiden Reinsurance Ltd.

Before we begin, I would like to note that the information presented here today contains projections or other forward-looking statements regarding future events or the future financial performance of the Company. These statements are based on current expectations and future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially from these expectations. We refer you to the documents the Company files from time to time with the Securities and Exchange Commission, specifically the Company's annual report on Form 10-K and our quarterly reports on Form 10-Q.

Some of our discussions about the Company's performance today will include reference to those non-GAAP financial measures and information that reconciles 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. Please also note that unless otherwise stated, all references to common share data in today's discussion are on a diluted share basis and comparative comments will refer to Maiden's results in 2014 relative to the corresponding period in 2013.

I will now turn the call over to Art.

Thank you, Noah. Good morning. Welcome and thank you for joining us today for our third-quarter earnings call.

Throughout 2014 we've continued to realize solid progress in carefully growing our underwriting portfolio, strengthening operating performance, and importantly, enhancing our operating return on common equity. I am pleased to report that our third-quarter results continue to reflect this trend with strong but disciplined revenue growth from all active segments, continued profitable underwriting results, growth in invested assets, growth in investment income, and importantly, continued improving operating returns on equity.

Maiden's results continue to benefit from our disciplined focus on lower volatility, non-catastrophe reinsurance business supporting the capital needs of regional and specialty insurance companies, along with strong underwriting performance from our AmTrust segment, reflecting continued solid performance in the small account workers compensation segment.

For the quarter, Maiden generated a historically high level of earnings of $0.38 of diluted operating earnings per common share, or $29.3 million. Importantly, we see opportunities to further strengthen results. Maiden's 13% operating return on equity during the first nine months of the year is evidence of the improved earnings power of Maiden's business since the replacement of the 14% coupon trust preferred securities in January of 2014.

For each quarter of 2014, our operating ROE has been comfortably above 10% and moving towards our targeted performance level of 15%. We will continue to work diligently to optimize our balance sheet, strengthen our underwriting margins, and grow investment income.

In the first nine months of 2014, net premiums written from Maiden have increased 13%. Excluding the canceled NGHC business, net written premium has increased 25%. During the third quarter, net premiums written grew 31% with both of Maiden's active operating segments contributing to growth.

In the diversified reinsurance segment, net premiums written were $220 million, or an increase of 17% from the prior year. In the US, organic growth for existing clients continues to be a strong driver along with the addition of several new client relationships.

As I've mentioned before, growth from existing customers is an important element of our business model and it actually allows us to expand relationships with customers that we already know and have credible experience with. As always, competition is strong in our mature marketplace. However, by carefully targeting our customers and focusing closely on their needs, we have been growing relationships and also winning new business as well.

Outside the US, Maiden's International Insurance Services union, or IIS, third-quarter premium volume was essentially flat, but business opportunities are plentiful through long-standing strategic partnerships and our UK-based, OEM-focused marketing team, which is now actively marketing our services and products to potential new auto manufacturing clients. As you will recall, the IIS unit is focused on partnering with insurers and auto manufacturers to deliver branded products to their consumers.

In Bermuda, we have continued to focus on international reinsurance opportunities, particularly in Europe, and we have made significant strides in the quarter as we have initiated our marketing efforts, focused on the capital needs of regional and specialty insurers in Europe.

In the AmTrust segment, we continue to see strong growth with net written premiums in the quarter totaling $386 million which is an increase of 49% from the prior year. This growth is primarily driven by the expansion of their small account workers compensation segment in the US and, of course, the Tower renewal rights transaction. Worker's Compensation pricing has remained strong, particularly in the markets of focus for AmTrust such as California, where they have developed a market-leading position in small account, lower hazard business classes.

We continue to be very satisfied with the quality of business ceded to Maiden from AmTrust. Similar to many of our clients, we work closely with our largest client during regular audit site visits and management meetings to ensure that we have a clear understanding of the underlying business and how it is performing.

For the nine months ended September 30, Maiden reported a combined ratio of 97.8%. That's up slightly from the 97.6% during the first nine months of last year. In the diversified reinsurance segment, the combined ratio for the first nine months was 98.4% and that is up from 98.1% in the prior year.

The diversified segment treaty portfolio you may recall has been impacted by a number of unrelated property losses in the US during the first half of the year. We implemented underwriting actions addressing our excess of loss programs over the last several quarters and we have observed more stable performance in the treaty portfolio. However, in the quarter we did experience elevated casualty loss activity, predominately from our faculty of commercial auto segment or business.

Absent these losses, diversified combined ratio would have been approximately 0.6 percentage points lower. We've taken underrating actions on the specific facultative accounts, and despite this elevated level of loss, our facultative book remains one of our highest margin portfolios.

In Europe, steps taken during the end of 2013 and early 2014 have resulted in improved profitability and the IIS business combined ratio was running at target for the first nine months of 2014. Of course, AmTrust continues to be a very profitable contributor to Maiden's results with a combined ratio of 95.6% in the first three quarters of 2014, which is largely unchanged from the same period last year, and remaining better than target.

We believe that the third quarter illustrates the growing earnings power of Maiden and the value of our highly differentiated business model, again focused on serving the non-cat needs of regional and specialty insurers. Importantly, we believe that we possess a number of significant competitive advantages that will continue to serve us well as we continue to build our business and strengthen our operating performance.

I would like to now turn the call over to our Chief Financial Officer, Karen Schmitt, to review the third quarter in greater detail. Karen?

Thank you, Art, and good morning. As Noah said earlier, unless otherwise stated, all references to common share data are on a diluted share basis and comparative comments will refer to Maiden's results in 2014 relative to the corresponding period in 2013.

Maiden reported record net operating earnings for the third quarter of 2014 of $29 million, or $0.38 per diluted common share, compared with $23 million, or $0.31 per diluted common share. The third-quarter operating ROE of 12.9% compares favorably to the 11.1% produced in the third quarter of 2013.

Before we get into more detail about the quarter, I would like to discuss one housekeeping item with regards to the revised structure of Maiden's reported segments.

As you will have seen in our earnings press release, there is no longer a segment called NGHC Quota Share. Instead, the results of the operations of the former NGHC Quota Share segment and the remnants of the E&S property business that was sold last year have been included in the other category. This revision has no impact on net income, operating income, or net income per common share reported in the current or previous periods.

In the third quarter of 2014, net premiums written totaled $605 million, an increase of 31%. The diversified reinsurance segment net premiums written totaled $220 million, an increase of 17%. Excluding the canceled NGHC business, net premiums written have increased 36%. The growth in the diversified reinsurance segments premium was largely the result of increasing shares of existing client business and underlying client premium growth with a modest amount of new business.

In the AmTrust reinsurance segment, net premiums written increased by 49% to $386 million, driven by favorable trends in business lines, particularly workers compensation, as well as new business from the Tower renewal rights transaction.

Net premiums earned of $592 million increased 17%. Excluding the canceled NGHC business, net premiums earned have increased 34%. Net premiums earned increased 18% in the diversified reinsurance segment to $233 million. The AmTrust reinsurance segment earned premiums were up 48% to $359 million.

Net loss and loss adjustment expenses were up 17% to $400 million compared to the third quarter of 2013. The loss ratio of 67.2% was higher than the 66.8% reported in the third quarter of 2013. As we have commented previously, the majority of our business is priced to a combined ratio; therefore, business mix changes between excess of loss and quota share business from period to period can impact the ceding commission. For example, if we write more excess business, we will see a lower expense ratio and higher loss ratio and vice versa for quota share business.

The combined ratio for third quarter of 2014 totaled 97.8% compared with 97.6%. The diversified reinsurance segment combined ratio was 99% in the third quarter of 2014, up from 98%.

In the third quarter of 2014, the diversified segment combined ratio was impacted by a modest amount of reserve deterioration, which was largely commercial audit business. The AmTrust reinsurance segment reported a combined ratio of 95.5% in the third quarter of 2014 compared to 95.6%.

Record net investment income of 29.5% in the third quarter of 2014 increased 27%. The average yield on the fixed income portfolio, excluding cash, is 3.56%. The new money yield on fixed maturities in the third quarter was 3.2%. Including cash, the average duration is 4.60 years versus an average duration of liabilities of 4.34 years.

Total investments increased 7% to $3.5 billion as cash generated from Maiden's business was put to work in fixed income securities, primarily investment-grade corporate bonds and government-sponsored entities. It is important to note that we are maintaining our conservative fixed income investment strategy.

Operating cash flow was $507 million for the nine months ending September 30 and $271 million for the quarter. Cash and cash equivalents decreased from $292 million at June 30 to $273 million at the end of the third quarter. As we put this cash to work we anticipate this will incrementally benefit our operating results.

Total assets increased 7.3% to $5.1 billion at September 30, 2014, compared to $4.7 billion at year-end 2013. Shareholders' equity was $1.2 billion, up 8% compared to December 31. Book value per common share was $12.33 at the end of the third quarter of 2014, or 11% higher than December 31, 2013.

Finally, I was very pleased that the Board of Directors had the confidence to increase the quarterly dividend by $0.02, an 18% increase, which recognizes the 29% increase in Maiden's operating earnings year-to-date compared with the same period last year. This is consistent with the Board's actions in the past. When they have seen an improvement in the run rate of the business, they have rewarded shareholders through an increase in the quarterly dividend.

I will now turn the call over to Art for some additional comments.

Thank you, Karen. Turning now to market conditions, we just completed several of our more important annual pre-renewal events. In the US, the NAMA convention, which is a trade association for mutual insurers, and the PCIAA, which is a large industry trade association representing over 1,000 member insurers. Additionally, in Europe we attended the Monte Carlo Reinsurance Rendezvous and the Baden-Baden reinsurance conferences.

I've commented in the past several quarters that while competition in our very defined market space is certainly not as intense as the competition in severity markets such as property cat, nevertheless we still see evidence of an intensifying competitive market in our target segment. It's clear that participants at these various meetings were beginning to express concerns about pricing pressures in local markets. Several rate tracking -- rate level tracking services in the US are indicating that the pace of rate level increases is moderating, but the trend in the primary market is still modestly positive. There are, as always, differences by geography and by line of business, but the trend is fairly clear.

Internationally reinsurance and primary markets remain competitive, but we believe that there is an increasing amount of interest from smaller companies to strengthen their capital in advance of risk-based capital rules or Solvency II. In our OEM-focused business in Europe, competition is stable and we believe there are opportunities to extend our business in this segment with a unique business model.

From a reinsurance deal flow perspective, we believe that we will have a significant number of quoting opportunities in year-end in the US and of course we continue to work with our current clients to expand relationships. Several clients and prospects have approached us to discuss the need for capital support following a challenging year of weather-related frequency activity.

From a renewal perspective, we have a number of contracts pre-negotiated and committed. We are fighting then, for the most part, clients that have seen adverse experience have been willing to adjust forward pricing with us when appropriate, and then a number of accounts with expected performance have been renewing as expiring.

Regardless of the opportunity, we will continue to take a disciplined approach to pricing and technical underwriting and, importantly, we will focus on delivering differentiated value to our clients. As I've indicated in the past, growth for the sake of growth is never an objective.

Internationally, in our diversified reinsurance segment, we see a significant number of opportunities to expand our auto manufacturing brand insurance solutions business to other OEMs and geographies and are actively in dialogue with perspective manufacturers as well as existing business partners. In the regional and specialty insurer market segment in Europe we are also beginning to market our unique capital solutions approach to capital-sensitive, small and midsized companies with a blend of traditional reinsurance solutions that are collateralized and partner-provided Capital Market solutions.

In addition, we recently established the strategic partnership with a very unique asset manager based in Dublin, the insurance regulatory capital. They are focused on originating and developing subordinated debt solutions that effectively respond to regulatory capital needs of private insurers and, in combination with our collateralized reinsurance, will assist in delivering highly-differentiated solutions to regional and specialty insurers in Europe and beyond.

Finally, from our largest client, AmTrust, we expect to see continued growth in their core small account business, reflecting both pricing power in select markets and the impact of the renewal rights transfer of the Tower business. We found that AmTrust remains focused on ensuring that profitability holds and we've seen no examples of weakening underwriting standards.

As we move forward, we remain confident that our differentiated lower volatility business model will continue to serve us well. We believe that our strategic position in our target markets, our growth opportunities across our business segments, and our strong and growing balance sheet, along with our disciplined underwriting approach, will help to drive increased earnings and returns.

Thank you very much. Operator, could you please open the line for Q&A?

(Operator Instructions) Matt Carletti, JMP Securities.

Thanks, good morning. Just have a few questions. First one is on the growth in diversified. It has been another strong quarter.

Can you just -- don't need exact numbers, but just maybe ballpark. You mentioned a few sources behind the growth: new business, growth with existing clients, obviously there could be rate and some other changes in there. Of the 16% year-to-date growth in diversified premiums, can you roughly ballpark which bucket has which amount?

Certainly the majority is coming from existing clients and I will give you an example. We were talking about this just recently with the Board.

We had one account where we had an excess position. It was in million dollar kind of excess contract; client came to us for additional capital support. Became a $20 million contract in the year. We have had others similar.

So I would say that significantly the preponderance of the opportunities are growth with existing customers. Karen mentioned it's a relatively small amount of new accounts, but, as you know, a lot of those new accounts become kind of engines for future growth. So I don't have exact percentages, but I would say it's dominant.

That's perfect. Very helpful and makes sense.

Second question is just on -- to give any -- I know it wasn't that large at 0.6 points I think you quoted, but just the adverse development in commercial auto, the factbook, can you just give a little color on what you think is driving that? I know that we've -- you aren't the first to see that. There's been many others that have dealt with it, but I'm just curious if it's the same sort of thing or if you're seeing something different.

I think we are seeing just some kind of additional case development that's occurring on select claims. Typically in most quarters we see ups and downs on individual claims and generally they tend to balance out. This quarter we had an elevated level that took us a little bit over.

It's still a relatively small amount of development. I'm not sure we would say at this point that it's a trend we expect to see continue, but we are watching it carefully. I think it's really a bit more severity on a number of claims that have already been reported.

Okay. Then last question just you mentioned in your closing comments there a new strategic partnership with an alternative asset manager in Dublin. Any more color you can give us around that? When the relationship goes live or is it already? And is it focused on all the EU or what's the scope of it?

Initially it's focused on the EU, select markets. I think that we have kind of been working with them through most of the summer and really have forged a kind of strategic relationship. As you know, Pat Haveron runs the Bermuda platform and he has been extensively partnering with them and actually visiting prospective clients and producers in Europe just sort of in preparation.

I think it's going to be a situation that we don't expect to see meteoric growth, but we definitely expect to see and are seeing deal flow developing. The interesting part of kind of the technology and approach they have developed is that subordinated debt, 7- to 10-year duration, is actually quite responsive to capital needs for many of the companies that are going to be capital-constrained in the Solvency II environment. So we think it, combined with reinsurance solutions, can really produce a very nice, differentiated, balanced approach to capital for a lot of these companies and we, frankly, think it's a nice entry point for us into that market.

Great. Thanks for the answers and congrats on the quarter.

(Operator Instructions) Randy Binner, FBR Capital.

Good morning, thank you. Just picking up on a couple follow-ups on the Irish or the Dublin alternative asset managers. So you are focusing on Solvency II solutions for capital-constrained European insurers. Can you just remind us, is that going to be kind of small, regional mutual companies in Europe? And can you give a sense of timing when that might kick in?

Sure. Our general view is that the large sort of public and multinationals are well prepared. They have developed their proprietary capital models. They've had them certified by the regulatory authorities.

It is the small to midsized companies that will probably have to different revert to default models, and for a lot of those companies we would like to help them understand that. But it's clearly a small to midsized company approach, much like the US. I think that's where we really can add the most value and develop really the kind of lasting capital partnerships that we want to bring to the mix.

So as far as opportunities, we do have some live opportunities that we are looking at currently and we will see how those develop. Solvency II still is 2016 implementation date, but the one thing that we have learned that, regardless of what ultimately happens with Solvency II, I think there is a heightened sense of awareness of risk-based capital across the marketplace. And we would like to be a solution provider for the smaller companies that may not have the same level of sophistication that need assistance.

When would you say the bulk of that opportunity is going to come though?

It's hard to tell. We know we are going to have quoting opportunities imminent, right? And we expect to see that through 2015. How many of those we land and turn into new opportunities it's anybody's guess.

We are pretty confident that the tools that we are bringing to the market are kind of unique and heavily differentiated, so we are cautiously optimistic that we can see some impact in 2015. But I would say right now it would be a bit of a guess.

Okay, thank you. Then on the commercial auto book, is that like one program? Can you share what accident years the business was written in and what kind of risks they were? Like was it tractor-trailers or was it delivery vans? Just a little bit of color on what's going on there.

Sure, Randy, I will take that one. As I think you know, we look at every customer every quarter from a reserve review standpoint and we have lots of ups and downs. Usually it just blends out o be pretty close to no change.

This particular quarter we had a few more positive movements. It wasn't really related to any particular underwriting year or accident year or class of business, frankly. There are little bits and pieces in various places and it just turned out that we had more positive movements than negative this quarter.

Right. Meaning more adverse development than positive?

More adverse, I'm sorry. Yes.

Right, got it.

(multiple speakers) upward in reserve amounts, yes.

Right. Okay, so just kind of broad, nothing like a bad program that had to get shut down. So what are the underwriting measures that you are taking then if it's broad based?

From a commercial auto standpoint, we are looking at some of the tractor-trailer long-haul trucking a little more closely as we have noticed that there's been a bit more severity there. But some of the other parts of the programs are really just -- it's just more randomness and we are not as concerned about that. But you are correct in asking earlier; tractor-trailers and long-haul trucking is something that we looking more closely at.

I would add, Randy, that those that w can kind of isolate to a specific customer where we see it producing adverse results, we are clearly working to strengthen pricing. Working with the client on risk selection as well.

So we have a performance management process that we instituted throughout the Company for many years. And when an account is performing out of target that initiates a whole process that really involves a workout plan to strengthen the performance of the business or to terminate.

The one thing that I would add is in this space, in the facultative area, this still continues to be our highest-margin business. So while we've seen some adverse development, even some of the trucking accounts that we are looking at, some of them continue to be very, very strong performers.

Okay, great. Then on capital. This is a question I think I ask on every conference call, but because of the growth, the premiums to capital, premiums to total cap or premiums to statutory surplus, it goes up. And so we have that metric we have that metric at like 1.6, maybe 1.7 in full-year 2015.

I know there's no magic rules on that operating leverage metric, but I would just be interested -- that has got to be high I think for Maiden and what you want to accomplish rating wise. And so I would just be curious kind of on an update. I think you have talked about having room for a little bit of debt in the past, but there's also got to be a ton of opportunity in the alternative reinsurance space to look at sidecars and other retro structures.

So can you just give us a feel of what your capital opportunities are for Maiden? Assuming -- because if I run rate this growth, I start to use up the capital pretty good in the model.

Yes, Randy, I think clearly the growth this year, a lot of that is being generated by the Tower acquisition and we will see some of that affecting us next year as well, but we think a fair amount is or will be in our numbers by the end of the year. That said, we don't anticipate the same level of growth in 2015, so we think things will moderate. We still expect to see growth.

And we are always -- we have been -- as a company formed in 2007, we have always been kind of making sure that we are kind of ahead of the curve on capital. We want to make sure that we obviously maintain our ratings and maintain a strong balance sheet for our clients. So we have a variety of levers, probably more today than we have ever had.

Obviously, as you correctly pointed out, we do have some room in terms of hybrid debt. We also, even before you get into more of the esoteric structures, the sidecars, and so on, we think we have some solid opportunities for retro support if we so desired. Whatever we do will follow the same historical path, which is look for the most shareholder-friendly, most accretive capital solution, but we don't believe that our hands are tied.

We are not going to suppress profitable growth opportunities. We are going to make sure that we have capital to support the profitable growth of the business.

No, indeed. It sounds like -- the other side of your comments earlier about the reinsurance market being competitive is that you should have better opportunities. So is it getting to a point where retro or sidecar is more attractive than debt maybe? Is it getting that inexpensive to try and tap into capacity providers that are out there?

It's a great question. To be determined, right? We do have active dialogue and we have had dialogue with a number of participants over the year and we will see, at the end of the day, whether we find a structure that works for us. But clearly we are looking at it from an efficiency, something that is accretive as to our results. I think we are cautiously optimistic that there are sources out there beyond just traditional capital markets solutions.

Okay, perfect. Thanks so much.

(Operator Instructions)

Well, there do not seem to be any additional questions. Thank you. I know it's a busy day for everyone, so thank you for joining us. We look forward to speaking to you next time. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.