State National Companies' (SNC) CEO Terry Ledbetter on Q4 2016 Results - Earnings Call Transcript

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State National Companies, Inc. (NASDAQ:SNC) Q4 2016 Earnings Conference Call February 24, 2017 9:00 AM ET

Executives

Rick Black - Investor Relations

Terry Ledbetter - Chairman and Chief Executive Officer

Matthew Freeman - President

David Hale - Executive Vice President, Chief Financial Officer and Chief Operating Officer

Analysts

Randy Binner - FBR

Matt Carletti - JMP Securities

Jeff Briggs - Singular Research

Operator

Greetings and welcome to State National Companies' Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Rick Black, Investor Relations. Please go ahead.

Rick Black

Thank you, Barrack. Welcome everyone to State National's fourth quarter 2016 year end conference call. With me on today's call is Terry Ledbetter, Chairman and CEO; Matt Freeman, President; and David Hale, CFO and Chief Operating Officer. This call is also being webcast and can be accessed through the audio link on State National’s website at statenational.com under the Investor Relations section.

Information recorded on this call speaks only as of today, Friday February 24, 2017. Before we continue, I would like to remind you that the statements in this discussion that are not historical facts, including statements of expectations of future events or future financial performance are forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties, and we caution investors that a number of factors could cause actual results to differ materially from those contained in any such forward-looking statements. These factors and other risks and uncertainties are described in detail in the Company's annual report on Form 10-K for the year December 31, 2015 and in the Company's other filings with the Securities and Exchange Commission.

In addition, the references in this discussion to EBITDA, a non-GAAP financial measure, reflect adjustments to net income for interest expense, income tax expense, and depreciation and amortization. The reconciliation of EBITDA to net income can be found in the Company's earnings press release.

Management believes this measure is helpful to investors because it provides a supplemental measure for evaluating core financial performance between periods.

I would now like to turn the conference call over to Mr. Ledbetter, Chairman and CEO. Terry?

Terry Ledbetter

Thank you, Rick, and thank you everyone for joining us on the call. With me today is our CFO David Hale and our President, Matt Freeman. I will begin by providing an overview of the quarter and full year 2016 and then I’ll turn the call over to David to review key financial metrics and to discuss our outlook. Matt will then comment on the industry trends receding in our business before we open the call for your questions.

We experienced strong performance and both are Lender and Program Services segments in the fourth quarter. A corresponding result enabled us to achieve the high end of our guidance range or Lender Services and to exceed the high end of our range for Program Services for the year.

These revenue achievements produced significant earnings growth and resulted in a 17.5% return on equity for the year. Both net income and EBITDA increased 10% and 2016 compared to 2015. Our capital efficient and fee per service business model has generated a three year compound annual growth rate of 30% and adjusted net income and 25% an adjusted EBITDA.

As specialty insurance services company, we operate two distinct business segments where we are market leaders. Our business models stands apart from other property and casualty companies based on our operating and risk characteristics. Over 70% of our pretax income is produced from our fee based Program Services segment. We have decades of experience operating our fronting business with our specialized credit underwriting, and credit monitoring policies and procedures.

The underwriting risk associated with our Lender Services business is predictable with low policy limits and a short loss payment period. These characteristics differentiate State National and allow us to produce more shareholder value than a traditional P&C company. Because of these attributes our strong management team and our capital efficient business model we have a long history of profitability and re-envision a strong future.

In 2016 positive macroeconomic trends to continue to support our growth and Lender Services due to increases and new car sales and rising loan balances. In Programs Services existing programs continue to grow and we're adding new client relationships. The growing global reinsurance and alternative capital market is being transformed by new structures and platforms, which are beginning to compress and realign the value chain between risk and capital.

State National has been a trusted provider of funding services for almost four decades as they highly rated and broadly licensed insurance carrier. This experience enables us produce business with growth premium leverage at four times the industry average. We retain virtually no underwriting risk and our Program Services segment.

Our successful history and proven experience has established our reputation in this market as the preferred conduit between the production of primary insurance risk and capital. We believe these dynamics position State National with a distinct competitive advantage and an expanding market.

I'll now turn the call over to David to review our financial results in more detail.

David Hale

Thank you, Terry. Total revenues in the fourth quarter of 2016 were $60.1% up 9% compared to the same quarter last year. Net income was $14.1 million or $0.33 per diluted share compared to net income of $13.9 million or $0.32 per share diluted share for the same quarter 2015.

Net realized investment gains were $1 million for the fourth quarter, consistent with $1 million in the fourth quarter of 2015. The impact at the realized net investment gains net of tax for the fourth quarter was $0.02 per diluted share.

Total revenues for 2016 were $217.1 million up 9% compared to 2015. Net income was $49.1 million or $1.16 per diluted share compared to net income of $44.7 million or $1.01 per diluted share in 2015.

Net realized investment gains were $2.7 million in 2016 up from $1.9 million in 2015. The impact of realized net investment gains, net of tax for 2016 was $0.04 per diluted share.

I'll now review some segment data. In Lender Services, premiums for the quarter grew 7.4% to $35.4 million. For the year premiums grew 9.8% to $129.7 million achieving the high end of our guidance range of $126 million to $130 million.

Contributing to this increase for new sales active account management, and growth in loan portfolios of existing accounts driven by rising automobile sales and higher loan balances.

The loss and loss adjustment expense ratio was largely flat for quarter of the net expense ratio decreased compared to the same period last year. These results were mostly related to higher earned premiums, which I just discussed.

For the year our net combined ratio improved to 84% compared to 86.5% last year. Our long term objective is to manage our CPI business to achieve a net combined ratio of 85% to 90%.

In Program Services, ceding fees were $20.9 million an increase of 12.3% compared to the fourth quarter last year. For the year ceding fees were $73.3 million an increase of 7.9% compared to last year and exceeding our guidance range of $68 million to $70 million. In the fourth quarter existing programs continue to grow and we continue to establish new product relationships for private programs.

In a thermal program is trending favorably with an increase of 54% in gross written premiums year-over-year. In the fourth quarter and the filler program contributed ceding fees of $4.4 million and $13.5 million for the full year. The growth in premium is attributable to the continued successful implementation of their transformative strategy in catastrophe exposed primary insurance.

We're pleased with the activity in our Program business including an increase of approximately $5 million and ceding fees for programs excluding our four largest clients in 2016 over 2015. This demonstrates the growth from our smaller and mid-sized programs.

Moving on to the balance sheet. Approximately $2.3 billion of State National's liabilities represented gross up for unpaid losses, loss adjustment expenses, and under premium liabilities, which have been ceded to our reinsurers and are primarily related to the Program Services segment.

Offsetting these gross liabilities our reinsurance recoverable assets for the same ceded business. Recoverables of approximately $1.7 billion are secured by collateral held trust funds for our benefit or letters of credit. And the remainder is ceded to highly rated well capitalized reinsurers.

Our balance sheet reflects low financial leverage with only $43.8 million debt and its interest only until the early to mid-2030. Our investment portfolio has a short duration and is primarily comprised of fixed income securities the majority of which have investment grade ratings. The portfolio was laddered to allow for reinvestment of funds as rates change.

Now I’ll discuss our 2017 outlook. We raised our diluted earnings per share range from a $1.10 to $1.20 to our new range of a $1.13 to $1.21. The underlying assumptions for this range are no anticipated realized investment gains or losses and outstanding share count of approximately $42 million shares and effective tax rate for the year of 36%.

General and administrative expenses of $71 million to $75 million net earned premiums of $137 million to $147 million and ceding fees of $69 million to $79 million.

With that I'll turn the call over to Matt.

Matthew Freeman

Thank you, David. At the onside of 2016 we saw certain headwinds in our business and we were able to convert throughout the year in the renewed opportunities by extending certain long term relationships. Our team did an excellent job in this regard, further solidifying our leadership position in the fronting market.

Furthermore our program sales and marketing efforts have increased our client basis small to mid-sized accounts. Due to our success in Program Services, we are anticipating growth for 2017, despite the planned one year step down of $4 million in ceding fees associated with our recent multi-year Nephila partnership extension through at least 2019.

Then Lender Services, we expanded our product suite to provide more customized solutions in the market, and we believe those enhancements have improved our client retention. In the early months of 2017, we see stable competition in the Lender space with modest organic loan portfolio growth within our customers.

In Program Services, we continue to see funds from the alternative capital and reinsurance market along with growing interest in exploring fronting solutions. General agents are drawn to State National’s model, which provides flexibility, stability and speed to market advantages that are not readily available elsewhere.

The influx of capital in the reinsurance arena has led to the compression of reinsurance rates, which historically have been predominantly focused on catastrophe exposed U.S. Property Insurance. These lower reinsurance rates are now driving industry capital to seek opportunity in the form of U.S. primary insurance risk both catastrophe expose property, and casualty lines of business.

State National continues to be the preferred conduit between risk and capital for these industry participants, as a highly rated and broadly licensed insurance carrier with significant and unique experience in this arena. We are the only major insurance carrier with decades of experience that provides fronting as a dedicated business.

We continue to see a high level of activity in our sales pipeline associated with our increased sales efforts and the elevated profile of State National in the marketplace. Our history of profitable performance along with these trends underscores our optimism about our business and the bullies that we are well positioned for continued growth and profitability.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] Our first question today comes from Randy Binner of FBR our Please go ahead.

Randy Binner

Hey good morning, thanks. I just want to start, I think I heard maybe a little bit of the new disclosure on filler and size I want to make sure I understood the numbers correctly, so I think that you said that in filler was up 54% year-over-year, with that regard kind of like your total fees from them or was that regard to just ceding fees from the filler?

Terry Ledbetter

That was actually premiums written by the filler.

Randy Binner

Okay, those top line. Thank you. And then the 4.4 in the quarter that is total of the total of ceding and capacity fees?

Terry Ledbetter

That’s accurate.

Randy Binner

And so what is - and then likewise in the 13.5 is some of those - so what - okay can you tell us what the breakout was of ceding versus capacity fees in the fourth quarter for the full year period?

Terry Ledbetter

Randy, we're not - we’re kind of keep it little more simple, we’re going to focus on the premium growth as well as the total fees for the time being.

Randy Binner

All right. And then yeah, Matt, I'd be kind of interested in just kind of your last comments there around - the kind of the demand for this solution from large capacity providers who want to write insurance business in United States. Is it any more kind of color texture and you give us any conversations with those capacity providers that it would kind of similar to what we’ve seen with the filler?

Matthew Freeman

So I guess that, thanks for the question, Randy. I think the way I catheterize that it is, I’m pleased and I recognize this is a bit of a general response. But the volume of activity and the volume of conversations, we’re having with partners or potential partners that are interested in fronting solutions, I would say is increasing, if you think about a kind of over the past year or longer time line, and I think the growth that we’ve experienced and seen in the business thus far we’ve been very fortunate that’s been quite broad based, meaning that it’s not focused on any particular client relationship that we are seeing growth across the board.

Randy Binner

And then just one quick one, on auto, your loan balances are high and the sales are higher. Is penetration rate change in all and the Lender business, I mean, is there any kind of credit deterioration that’s helping you or is the penetration where I think it’s - I think the last to maybe 1.25% or 1.30% is it still at that pretty lower level?

Matthew Freeman

It has kicked up very slightly I mean into the 1.3%, 1.4% range, but I think is you’re alluding to that remains is that kind of historically low end of the spectrum.

Randy Binner

Yeah. Are you surprised we made it this far without it picking up more than usual from your experience, could you dealing this business line for a long time. Meaning that I mean…

Matthew Freeman

I will candidly admit it’s extraordinarily difficult to predict when those trends will change. I think we’re quite proud obviously we’ve been able to deliver this level of performance while the penetration rate has remained at the lower end of the spectrum.

Randy Binner

All right. Great. Thanks for the response.

Operator

The next question is from Matt Carletti of JMP Securities. Please go ahead.

Matt Carletti

Hey, thanks. Good morning, guys. Just a few questions, the first one, I saw on the news recently you guys signed a deal and there will be small to start, but that let’s called an InsureTech opportunity JD insurance. Could you talk a little bit about not that deal specifically, but just about the level of interest in the opportunity there is kind of technology and insurance come together. Have you guys seen a lot of inquiries or demand for your fronting services as a lot of these start-ups look to get involved in the market?

Terry Ledbetter

Yep, Matt. Thanks for that question. Certainly InsureTech is a space within the insurance industry that’s been gaining a lot of attention and a lot of investment dollars recently. One of their key things that states focuses on is ensuring that they’ve got the right kind of user experience in model to attract business and opportunity. We use that we are uniquely positioned to help as many of those companies entered insurance space with our fronting solutions. So we have that a number of conversations with various parties there and I would hope over the foreseeable future, we see some growing opportunity from that space.

Matt Carletti

Yeah. Great. And then Matt, another one probably for you. Yeah, you’ve talked a little bit in past quarters and your Investor Day about going through a process and looking to potentially add kind of a third segment or business to State National, but being kind of a very processed driven venture. Is there any update on kind of how that’s going or just stay tuned.

Matthew Freeman

Sure. We do continue to kind of actively look at opportunities to expand the platform. We are attending to be quite selective and opportunistic on that front. We have a general bias towards businesses that will certainly be supportive facilitating transactions in the insurance arena with the biased toward e-generating businesses. But it is especially we will continue to review and run the right opportunities present themselves we will pursue that.

Matt Carletti

All right. Great. Thanks lot for the answers and congrats on a nice quarter and year.

Matthew Freeman

Thanks, Matt.

Operator

The next question comes from Jeff Briggs from Singular Research. Please go ahead.

Jeff Briggs

Hi guys. Quick question on the collateral protection line, I know you guys have the range of 85% to 90% for your target for combined ratio, and you did - give you better than that this year do you see just contains on the market that sort of moving back into that range or do you think it has favor and there is a fixed pack up that sort of counterbalances or any other growth in the premiums. So any comment on that will be helpful?

Terry Ledbetter

Well. I think our 85% to 90% target is really a long range kind of go, we expect it to move in that direction over the long period of time. In the short run, we see some pretty good dynamics for us our pricing account management and wouldn’t expect it to move dramatically up in the next year.

Jeff Briggs

Okay. Thanks, it’s helpful.

Operator

The next question is from Randy Binner of FBR. Please go ahead.

Randy Binner

Hey, thanks for the part two. There’s quite a bit of - I think it’s quite a bit of lease headlines around the model line insurers, you write homeowners insurance mostly in Florida, but also in the Southeastern United States in particularly in Florida, they’ve had this assignment of benefits problem if you will and those companies can do not care of A.M. Best ratings that there are a lot of the homeowners risk down there.

And so it seems like that whole dislocation might be something that creates opportunities for capacity providers, I saw that I think that a Spinnaker certain of something small within MGA. And so, is there any comment you can give us on kind of if dislocation among model line market for homeowners and in the Southeast is, it something that could potentially create opportunity for you to fund more premiums going forward. And in is that maybe some of what we actually have seen in the better top line growth from your key partner there and in the fourth quarter?

Terry Ledbetter

So far, Randy it’s not what’s driving the growth. We have received some calls, but we have the relationship with Nephila. Whenever we receive calls and inquires like that if we see them is viable. We will have a discussion with Nephila if see there’s a way for us to partner. I think it is very challenge - it’s going to be very challenging for those companies that have the demo tax rating to pivot to start using an A rated company. So that what I would expect to happen that could be beneficial to both State National and Nephila is some of that business will migrate to distribution that’s already in place for State National and the Nephila relationship, but so far the growth you have seen is not related to that.

Randy Binner

Whereas the growth, what’s been driving the growth as far then?

Terry Ledbetter

I think its Nephila methodically rolling out their strategy and being very effective at executing.

Matthew Freeman

Randy, which your question related to growth overall or growth in Nephila?

Randy Binner

It’s Nephila.

Matthew Freeman

Okay.

Randy Binner

I mean just thinking about the dislocations in the model lines and seeing what’s Spinnaker did, and just thinking about it’s kind of a classic setup, because you have a lot of need for insurance down there and you just don’t have - you just don’t have insurers with the right rating in even for demo tax. So it just seems like a natural fit.

Matthew Freeman

Yeah. I just reiterate. We don’t have a sense for - I mean we’re not adding new programs directly, and I would think the benefit comes from expanding the distribution that’s currently in place with State National and Nephila.

Randy Binner

Yeah. I mean I guess the follow-up there, because the year has exclusive rights. So you couldn’t add new ones but, is there - and I think you touched on this before Terry, but you’re not with other you know because I think you have two other front and you can nearly for fronting carriers to occur Avios [ph], I’ll say quote on quote in the market, I don’t know how established there, but is that something you’re bumping into a lot or it mean is that affecting you from a competitive perspective?

Terry Ledbetter

Now, we do occasionally run into them, but it’s a huge market as you know Randy probably $35 million to $40 million in premium. And so I view as a healthy market, I also see the opportunity being very significant just because of the size of the market. We do have and have competition primarily with what we would call direct writes that have written program business for long time.

Randy Binner

All right. Great, thanks.

Terry Ledbetter

Thank you everyone. And we will talk to you on our next call.

Operator

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

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