Third Point Reinsurance's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov.12.13 | About: Third Point (TPRE)

Third Point Reinsurance Ltd. (NYSE:TPRE)

Q3 2013 Earnings Call

November 12, 2013 9:30 AM ET

Executives

John Berger – Chairman and CEO

Robert Bredahl – CFO and COO

Daniel Loeb – CEO, Third Point LLC, Investment Manager

Analyst

Michael Zaremski – Credit Suisse

Eric Best – Citi

Kai Pan – Morgan Stanley

Jay Cohen – Bank of America-Merrill Lynch

Amit Kumar – Macquarie

Operator

Greetings and welcome to the Third Point Reinsurance, Ltd., Third Quarter Earnings Conference Call. (Operator Instructions) It is now my pleasure to introduce your host Robert Bredahl, Chief Financial Officer and Chief Operating Officer. Thank you, Mr. Bredahl. You may begin.

Robert Bredahl

Thank you, operator and welcome to Third Point Reinsurance Ltd.’s earnings call for the third quarter of 2013. This morning we issued an earnings press release, which is available on our website www.thirdpointre.bm. A replay of today’s conference call will be available until November 19, 2013 by dialing the phone numbers provided in the earnings press release and through our website following the call. Leading today’s call will be John Berger, Chairman and CEO of Third Point Re, but before we begin please note that the management believes certain statements in the teleconference may constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995.

Forward-looking statements include statements about expectations, estimates and assumptions concerning future events and financial performance of the company and are subject to significant uncertainties and risks that could cause current plans, anticipated actions and the company's future financial condition and results to differ materially from expectations. Those uncertainties and risks include those disclosed in the company's filings with the U.S. Securities and Exchange Commission. Forward-looking statements speak only as of the date they are made and the company assumes no obligation to update or revise them in light of new information, future events or otherwise.

In addition, management will refer to certain non-GAAP measures, which management believes allow for more complete understanding of the company's financial results. A reconciliation of these measures to the most comparable GAAP measures is presented in the company's earnings press release.

With that and at that this time, I’ll turn the call over to John Berger.

John Berger

Thanks, Rob. Good morning and thank you for taking time to join us for our third quarter earnings call. In addition to Rob Bredahl, our CFO and COO, with me today is Daniel Loeb, CEO of Third Point LLC, our Investment Manager. I’ll provide an overview of our financial results. Daniel will discuss the performance of our investment portfolio and then Rob will discuss our results in more detail.

I’m pleased with our results in the third quarter, our first quarter as a public company. We generated $46.6 million in net income or $0.46 per diluted share, which brings our net income for the first nine months of the year up to $147.2 million or $1.59 per diluted share. In last year’s third quarter and first nine months, we generated net income of $39.6 million and $38.7 million respectively. This quarter’s results were driven by excellent investment results and a reinsurance operation that continues to grow according to plan and is beginning to contribute to net income. The return on our investment portfolio managed by Third Point LLC was 4.3% in the third quarter and 16.9% in the first nine months of the year.

We generated an underwriting loss of $4.9 million in our Property and Casualty segment in the quarter, but our investment income on the float generated by our reinsurance operation was $7.1 million. Our reinsurance portfolio continues to perform as expected and we had no net reserve movement. In last year’s third quarter, our first year of operation, we produced an underwriting loss or $5.8 million and investment income on float was less than $100,000.

Although reinsurance market remains extremely competitive, margins in our targeted lines of business are stable. Our combined ratio for the quarter was 107.9% versus a 117% in last year's third quarter. As we continue to grow and assumingly maintain current underwriting margins, our underwriting results will improve as general and administrative expenses drop relative to premium.

As a reminder, our strategy is to write reinsurance contracts with attractive risk adjusted returns and to invest the float generated from this activity in a separate investment account managed by Third Point, LLC. We do not write excess of loss property in Cat business on our rated balance sheet, but rather write Cat reinsurance on behalf of the separate Cat risk fund. We made a $50 million investment in the Cat fund and so we have so much exposure to Cat risk and the Cat rate environment, but this exposure is limited and contained, especially relative to good traditional reinsurers.

In today's competitive market, we focus mostly on what we consider to be less volatile lines of business and types of transactions, where the insurance company buyer is in need of capital in the form of reinsurance. We are pleased with a large number of opportunities brought to us by brokers and our ability to originate deals through our strong relationships because selectivity of course is a key to profitability in a competitive market. We are seeing opportunities that meet our underwriting standards from smaller homeowners companies, non-standard auto writers, mortgage insurers and workers compensation insurance companies that focus on states where we find market conditions attractive.

Also we’ve seen a growing number of opportunities from distress companies where there's less competition and where we can structure surplus relief solutions while balancing the risk assumed against our expected profits.

I will now hand the call over to Daniel Loeb, who will discuss the performance of our investment portfolio during the third quarter.

Daniel Loeb

Thanks, John, and good morning, everyone. The Third Point Reinsurance investment portfolio managed by Third Point LLC returned 4.3% in the third quarter bringing year-to-date returns to 16.9% net of fees and expenses. The Third Point Reinsurance account represents approximately 10.5% of the assets of funds managed by Third Point LLC.

We generated positive results across each of our strategies, long short equities, corporate and structured credit, and macro investments during the third quarter. Returns were led by the equity portfolio which contributed 3.5% or 80% of total gains. As of September 30, our equity investments have gained 31.6% on average exposure year-to-date versus the S&P 500’s 20% gains, with approximately half the value at risk. Performance has been driven by profits in several key activists positions as well as by many smaller investments across sectors and geographies.

The quarter's equity returns were attributable to successful, single name stock selection resulting in significant alpha generation with modest volatility. Long exposure decreased in July when several positions reached their price targets and were sold. The most notable of these was Yahoo!’s repurchase of two-thirds of our investments at the previous day's closing price of $29.11 per share in July.

At the time of the sale, our Yahoo! investment had an IRR of 53%, a total realized and unrealized gains of $1.1 billion since inception in aggregate across all of Third Point's funds. Corporate credit added 0.4% to Q3 returns as both performing and distressed credit positions delivered solid performance.

As of September 30,, our corporate credit portfolio has returned 15.5% on average exposure, year-to-date or more than 1000 basis points over the Barclays high-yield index. Sovereign credit has also continued to be a key area of focus. Our sovereign portfolio was up 12.4% on average exposure in Q3 adding another two-tenths of a percent to returns in the macro portfolio for the quarter.

Finally, mortgages have continued to perform well contributing 0.2% to Q3 returns. Through September 30th, our book has returned 22.1% on average exposure. Despite fairly consistent levels of exposure, the portfolio's composition has shifted throughout the year. For example, we’ve been selectively adding seasoned subprime mezzanine bonds recently after selling most of those holdings during the rally and those securities in the first quarter.

We’re cautiously constructive about the investment environment in the near future and expect exposures to remain relatively consistent with current levels. We will continue to focus on uncovering event driven opportunities, especially in special situation equity positions.

Now, I'd like to turn the call over to Rob to discuss our financial results.

Robert Bredahl

Thanks, Daniel. As John mentioned, we generated $46.6 million in net income in the third quarter, which translates into earnings per diluted share of $0.46. Diluted book value per share increased by lower amount of $0.28 or 2.3% due to $24.6 million onetime expenses related to our IPO. These were mostly bank underwriting fees. These expenses were netted against the capital raise and not expensed through our income statement.

In our Property and Casualty Reinsurance segment, gross premiums written increased 5% to $43.7 million for the three months ended September 30, 2013 from $41.7 million for the three months ended September 30, 2012.

For the first nine months of 2013, gross premiums were increased 42% to $231.2 million from $162.5 million. Third Point Re began underwriting on January 1 2012. As John mentioned increases in gross premiums in 2013 are the results of successful development of underwriting relationships with intermediaries and reinsurance buyers.

We're very pleased with our acceptance in the market and increasing deal flow we are seeing, still it's worth noting that we focus on a limited number of larger transactions and therefore there may be significant changes in premium from period to period. Net premiums earned for the three months ended September 30 2013 increased 80% to $61.8 million. Net premiums earned for the nine months ended increased 47% to $155.8 million. The three and nine months ended September 30, 2013 reflect net premiums earned on a larger in-force underrating portfolio compared to the three and nine months ended September 30, 2012.

In addition, for three and nine months ended September 30, 2013 including net premiums earned on $17.5 million and $39.8 million respectively related to retroactive reinsurance contacts. These were reserve covers where we record the gross premiums written and earned at the inception of the contract. The underwriting loss to the Property and Casualty Reinsurance segment for the third quarter was $4.9 million and for the nine months ended September 30, 2013 it was $12.1 million. These results compared to underwriting losses of $5.8 million and $19.7 million in the three and nine months periods ended September 30, 2013 respectively.

The combined ratio for the first nine months of 2013 was 107.7% and compared to 131.3% in the previous year's first nine months. The improvement in underwriting results is due primarily to crop losses recorded in the 2012 period and a drop in general administrative expenses as percentage of earned premium. For the nine months ended September30, 2012, Third Point Re recorded a $5.2 million underwriting loss from the property insurance portfolio due to the severe drought suffered by most of the U.S farm belt.

The catastrophe risk management segment, which includes the combined results of our Cat fund, our Cat fund manager and our special purpose Cat reinsurer generated a net income of $2.7 million in the third quarter and $2.6 million for the first nine months for the year. Since our Cat risk segment began operations in January 2013 there are no comparable results from 2012. Net assets under management in our Cat fund as of September 30, 2013 were $100.5 million.

Investment income has been very strong in 2013. In the third quarter of 2013, Third Point Re recorded net investment income of $53.4 million compared to $47.7 million for the third quarter of 2012. As Daniel explained, the return on investments managed my Third Point LLC was 4.3% for the three months ended September 30th 2013 compared to 6.1% for the same period of the previous year.

For the nine months -- first nine months of 2013, the company recorded net investment income of $166.1 million compared to $63.9 million for the nine months ended in September 30 2012. The return on investments managed by Third Point LLC was 16.9% for the nine months ended September 30 2013 compared to 8.4% for the first nine months of 2012. In addition to the factors discussed by Daniel, net investment income for the three and nine months ended September 30 2013 also benefited from higher average investments managed by Third Point LLC compared to the prior year periods due to retained earnings, the net proceeds generated by Third Point Re's IPO and float contributed by our reinsurance operations.

I'll now hand the call back to John Berger.

John Berger

Thanks, Rob. We had a solid quarter and continue to develop according to plan and demonstrate the benefits of our business model. Third Point LLC’s performance as our invest manager has been outstanding and the while reinsurance market remains very competitive, we are pleased that we’ve been able to participate in enough opportunities that meet our underwriting standards, to continue to grow according to plan. I’ll now open the call up to questions, operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) And our first question comes from the line of Michael Zaremski with Credit Suisse. Please proceed with your question.

Michael Zaremski – Credit Suisse

Hi, good morning, gentlemen.

John Berger

Good morning, Michael.

Michael Zaremski – Credit Suisse

First question is on underwriting side. I guess you have no major wind events in the U.S. once again this year. How do you guys think pricing for many of the surplus relief deals you focus on will be impacted and I guess related – will citizens, Florida depopulations or the clearinghouse plans to the upcoming year’s growth strategy?

John Berger

I think there are two factors going on with the surplus relief deals. One is, with Cat prices going down makes the quota shares potentially more attractive, that’s a positive. A negative is to the extent that traditional reinsurers are being pushed out of the traditional Cat market, they may seek to add more catastrophe protection to those surplus relief deals. So it’s unknown right now, but potential positive and potential negative. The Florida citizens deal, clearly I think that’s a positive for the industry.

Robert Bredahl

Michael, did you ask if they have De-pops from citizens?

Michael Zaremski – Credit Suisse

Yeah, De-pops and/or the clearinghouse -- certainly the clearinghouse starts soon.

Robert Bredahl

Right.

John Berger

Yes, I think to the extent, there are more companies, there are more reinsurance buyers, that’s a positive for us.

Robert Bredahl

And we’ve seen a couple of deals, surplus relief deals from companies that are doing De-pops.

Michael Zaremski – Credit Suisse

Okay, got it. And I guess switching gears to the investment portfolio, it's probably for Dan. Can you update us on how the investment portfolio is positioned going into year end. Obviously, U.S. equity markets continue to have a strong run. You used the words cautiously optimistic. Do you expect some of your long positions to take a breather? Thanks.

Daniel Loeb

Well, it’s always difficult to predict what the – what our positions will do over a six week period. So I don’t – I wish my crystal ball were more accurate. Obviously I still – I really like the positions that we have and that’s why we’ve committed capital to them. Maybe I was a little too guarded in the term cautiously optimistic, given it’s particularly in the near term which is where I think your question related to, given the monetary policy here, the actions taken by Draggy [ph] last week in Europe and what’s going on in the UK, Japan and even China, we sort of have a global put to equity. So I feel like we’re in a mode where economies around the world, developed economies are trying to inflate and that’s usually a good thing for equities.

Michael Zaremski – Credit Suisse

Okay. And I guess just a follow up, Dan. You used the word target price, I guess, said another way, is the gap between current prices and your target prices narrower than it was earlier in the year?

Daniel Loeb

I mean some are, some aren’t. We’ve added some – I mean the positions that have appreciated to our target prices or closer to our target prices like Yahoo!, for example. We’ve reduced – we’ve recently put on some new positions, which have much higher target prices. So it’s something that we’re continually turning to the portfolio and exiting positions that appreciate and reach our target prices and selling and adding to things where we see more upside an opportunity.

I mean, one thing I just want to say about target prices is, you have to be a little bit expensive about how you think about things. I mean, you may have a stock that you think is worth X today, but because of the nature of the business they're in or the way that the management team compounds capital over a couple of year period, you might have a higher target price. So all these things have to be sort of put into context whether you’re talking about a shorter term target or a longer term target and there’s no – it’s more art than science determining what constitutes having reached or not reached the target price.

Michael Zaremski – Credit Suisse

That’s helpful. Thank you.

Operator

Thank you. And our next question comes from the line of Eric Best with Citi. Please proceed with your question.

Eric Best – Citi

Hi, thank you. So I don’t think [ph] that you could discuss a little more your expectations regarding the growth potential for the Cat fund and do you still expect to have another closing in the fourth quarter and if so any indications about the amount you may be able to raise?

John Berger

We will have a close in the fourth quarter. It will probably be quite modest, as I think anybody following the space knows there’s pretty good headwind from the competitiveness of the rate environment. There was also a lot of other people out there trying to raise money and clearly our game plan is a long term game plan, having a three to five year track record is critical in raising funds. So we’ll work on establishing that and it’s at $100 million, which is on the smaller side, but given the strategy we have for it, we think it’s something that works and it’s something of potential value, great value to us.

Eric Best – Citi

Okay, thanks. And if I just ask one other -- then if you can talk about what lines you are seeing the most attractive opportunities to write business currently?

John Berger

It’s tough to generalize – our strategy is to – we have fewer deals and they tend be larger deals and so it could be any given line of business where the economics line up for us. The homeowner quota shares, those are – we think are going to trend well. We have some non-stated auto deals, but we also as, Rob, as I mentioned before, we’re seeing – we’re just seeing a lot of interesting one off deals. Despite the apparent health of the industry, there are problems out there. There are companies with issues out there and we’re well known as problem solvers, we’re seeing a good flow of these one-off type deals.

Eric Best – Citi

Okay. Thank you for the comments.

Operator

Thank you. And our next question comes from the line of Kai Pan with Morgan Stanley. Please proceed with your question.

Kai Pan – Morgan Stanley

Good morning. This is Kai Pan calling in for Greg Locraft and congratulations on good start as a public company, the first question actually for Daniel. Third Point fund is returning about 10% to capital investors, could you elaborate a little bit on that and will this limit the Third Point Re’s ability to invest the growing investment portfolio with Third Point LLC.

Daniel Loeb

Yeah, I don’t really have any further comment on that and we’ll be sending out a letter to our investors shortly about it. We have said however that the return of capital is – excludes the public funds TPRE and Third Point offshore investors are publically listed fund in the UK.

Kai Pan – Morgan Stanley

Thank you. Second question probably for John is on the combined ratio. The combined ratio improved significantly year-over-year, both the loss ratio as well as expense ratio. When do you expect to achieve underwriting profitability?

John Berger

Yes, we think if we can – if we can perform as we hope to, as we have in our plan that below a hundred is achievable, the latter half of next year or early part of 2015.

Kai Pan – Morgan Stanley

That is just a clearance [ph] of that, is that, that’s not assuming sort of any significant underlying improvement on the pricing side, is that right?

John Berger

That’s correct. If we just kind of – the market just pretty much stays where it is or deteriorates a little bit, we think that’s achievable. There’s no optimism baked in there.

Kai Pan – Morgan Stanley

Okay. Great.

John Berger

It's a function of scale Kai, so we’re booking deals at composite ratios. They've been very consistent from the start. As we grow our G&A expenses become a lower percentage of our earned premium and that’s where we’re going to – that’s why we’re going to pierce the 100% combined ratio.

Kai Pan – Morgan Stanley

Great, thank you. Last question actually for Rob, is it – do you have a number for the float at the quarter end?

Robert Bredahl

Yes, it was, at quarter end it was a hundred – I mean -- I think we have $176 million.

Kai Pan – Morgan Stanley

Thank you.

Operator

(Operator Instruction) Our next question comes from the line of Jay Cohen with Bank of America. Please proceed with your question.

Jay Cohen – Bank of America-Merrill Lynch

Yeah. Thank you. Good morning. I got a couple of questions. I guess first on the loss ratio. You obviously -- your portfolio continues to involve and change, that number has varied by 20 points over the past five quarters. As you look at the third quarter loss ratio, do you view this as a fairly normalized number or should we expect that variability to continue to swing quarter-to-quarter.

John Berger

Jay, I think the variability will be down. Last year, we had those swings, we had $90 plus millions of earned premium, almost half of it was from crop business, just a nature of that business. It earns over 12 months. Other new business comes on, a lot of the business earns over 24 months. So almost half of our own premium was crop and it was a terrible crop year because of the drought. Now crop as a percentage of our earned premium is much lower, so even if you had the worst drought in 50 years again it just wouldn't have the same dramatic impact. We don't have the property cat excess or loss. So we really don't have that volatility on the book. So I think the swings will be more mitigated.

Jay Cohen – Bank of America-Merrill Lynch

And this number is a reasonable number to consider a normalize number?

John Berger

I probably wouldn't go that far, Jay. Just we're still relatively young and we're growing. Also, we've done a couple of reserve covers that have very high loss ratio.

Daniel Loeb

Now high, high means 100. It doesn’t mean 150. We're not writing discounted loss reserve deals.

John Berger

Yes. So the mix of business will still from quarter-to-quarter – will still push that loss ratio around. And if you look at the deals we're writing, those with higher expected loss ratios have lower expenses built-in and vice-versa. And so we're getting to a normalized level, but we're not quite there yet.

Jay Cohen – Bank of America-Merrill Lynch

Got it. And I guess the other question -- I remember to take this offline, but I'll throw it out there. The invested assets, even if you are throwing cash, didn't seem to change too much from the second quarter despite the IPO and I'm wondering where some of these other assets are in the balance sheet right now.

John Berger

Yeah. I think if you are looking at the balance sheet, the balance sheet includes the number of asset categories from our separate account as well as liability categories. If you've netted all of that down, you'd come up with a NAV number or a number that represents the money invested with Third Point. And that number has grown. I mean, the proceeds for the IPO went into our separate account and we also added some more money in the way of float. So it has grown and I can help you with those numbers, Jay, offline.

Jay Cohen – Bank of America-Merrill Lynch

That's great. And then I guess maybe last question if you don’t mind. Clearly you guys are always working on deals and stuff in the pipeline, the year-over-year growth in this quarter was not as big. But we know that's going to jump around a lot. Do you see the pipeline in such a way that you have any clarity into the fourth quarter or first quarter where you see some big deals that may be coming onboard?

John Berger

That's tough to predict, Jay. We're really concentrating on larger deals. So if we hit on those, the numbers will swing up; if we don't they won't. I think one thing too over time you'll see probably more premium volume volatility than with other companies because of the nature of our underwriting approach of looking for larger deals. So they are just really hard to predict. We have a very good pipeline. We're optimistic. But yes we'll see what the next few months bring us.

Daniel Loeb

I would also throw in that, I wouldn't read much into the third quarter. It was third quarter of the third quarter. It’s always the -- hello?

Jay Cohen – Bank of America-Merrill Lynch

I'm here. I couldn't hear you guys with that though.

John Berger

Okay. What we're saying is that don't put too much curiosity on the third quarter premium. That's historically a very light quarter. You know the mix of the business we wrote this year over the last year changed dramatically. We're looking at larger deals, a lot of one-off deals. So any quarter can be bigger or smaller, just based on whether we hit on these deals or not.

Jay Cohen – Bank of America-Merrill Lynch

Right. Now that makes sense. Thanks guys.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Amit Kumar with Macquarie. Please proceed with your questions.

Amit Kumar – Macquarie

Thanks and good morning. I guess, just a quick follow-up on the last question. Based on the investment performance, how are you thinking about your premium to equity leverage for 2014?

John Berger

We don't give guidance on gross premium. But I think we're pleased with our growth pathway right now and expect that to continue. And given that we have more capital, we've opted what we expect to write next year.

Robert Bredahl

I think too, now everybody talks about the market -- current market conditions. It's a very competitive time. We're in no hurry to deploy our capital on the underwriting side. We're lucky to be associated with Third Point LLC. All our capital is fully deployed on the investment side. So we think we have a nice growth pattern for the next few years. But we're in no hurry to fully deploy the capital on the underwriting side. When and if there are changes in the market, we want to be prepared to take advantage of those. So we like what we're seeing. We like the number of deals we're hitting. We like the growth rate we have, but again we do not feel great pressure to accelerate growth just for growth sake.

Amit Kumar – Macquarie

Got it. The next question is on the cat fund asset. I think you mentioned $100 million number. Do you think you are still on track for I guess getting to $300 million or $400 million or has the thought process changed based on the landscape.

John Berger

I think up several things. One is clearly the market is more competitive than when we started. Our game plan isn't to write the big retrocessional high octane stuff. We are going after regional business. Access to that business is harder, but we think we have a good way to go about it. Fund raising has been slow and I think a big part of that is just the negative news about where the rate levels are. And then -- we're new, we're going to have one year track record. It's hard coming out in this environment new and raising a lot of money.

So I think for the short medium term, it's going to be tough to show great growth on the asset side and that's fine. We will -- the idea is quality, not quantity. And if we can -- we think we're at a good critical minimum size, we can be a factor in the markets we've chosen and we'll grow. A lot of the growth potential is really determined more by the market than by us. We're out there swinging in pitches with the various investors. And over time we will line up more capacity.

Amit Kumar – Macquarie

Got it. And does the relationship -- how does the relationship at the Hiscox evolve over time?

John Berger

Hiscox is -- clearly they are the best company in London, one of the best, best, best companies, best run companies in the world. It's a very good relationship. How long will it last, we don’t know. We have the two year commitment with them. The things are good. The cooperation is good. I think we continue to cooperate on the underwriting side where we do get regional business from Hiscox that would be tough to access on our own. So overall the relationship is very good.

Amit Kumar – Macquarie

Got it. And just I guess one final question, based on the market opportunities you are seeing and then maybe I might take this offline, has your view changed on sort of the basket between property, causality and specialty versus the time of the IPO.

John Berger

At the risk of sounding cavalier, we don't spend a lot of time on like what the optimal -- if I understand your question correctly. If I've answered incorrectly, jump right in. We don't spend a lot of time on, say -- we want a third property, a third casualty, a third specialty, what kind of take whatever makes sense again subject to the constraint of on the property side how much property cat exposure do we want to have on our balance sheet. And especially given our approach of looking for fewer, larger deals, our mix can change dramatically from quarter-to-quarter, just by adding one or two deals, but we spend no time thinking about the optimal mix of our business.

Amit Kumar – Macquarie

Okay. That's all I have. Thanks for the answers.

John Berger

Thank you.

Operator

And I see we have no further questions at this time, I would like to turn the call back over for any closing comments.

John Berger

Well, thank you very much. We're -- as we said in the beginning we're pleased with our progress. We're not yet two years old. But we like the progress we've made. This is our first quarter as a public company. And that in itself was a good achievement. So we thank everybody for dialing in today.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. And thank you for your participation.

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