Tiptree Inc. Q3 FY2020 Earnings Call

Greetings and welcome to Tiptree Inc.'s Third Quarter 2020 Earnings Conference Call. I would now like to hand over the conference to your host, Sandra Bell, Chief Financial Officer. Thank you. You may begin.

Good morning, and welcome to our third quarter 2020 earnings call. We are joined today by our Executive Chairman, Michael Barnes; and CEO, Jonathan Ilany. You can find the slides that accompany this review on our Investor Relations website. Please note that some of our comments today will contain forward-looking statements based on our current view of our business, and actual future results may differ materially. Please see our most recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. Before I turn the call over to Michael, just a few additional housekeeping items. Today, we will discuss certain adjusted or non-GAAP financial measures, which are described in more detail in this morning's presentation. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our SEC filings, the Appendix to our presentation and are posted on our website. With that, I will turn the call over to Michael.

Thank you, Sandra, and good morning to everyone. Our strong results for the third quarter show the continued resilience of our core operations with operating EBITDA of $31.9 million, up significantly from the prior quarter. Year-to-date revenues, excluding mark-to-market, were up 17%, and operating EBITDA for the same period was $70 million, an increase of 64% from the prior year. Despite the challenges of operating under COVID-19 constraints, our businesses have continued their positive trends. Production and sales volumes are at all-time highs in many of our product lines and businesses, as management and employees have adapted well to the new environment, staying dedicated to serving our customers while pursuing new opportunities. Based on our belief in the strength and future growth of the company, Tiptree has repurchased close to 1.5 million shares so far this year at an average discount of 37% to book. In addition, senior management has also directly purchased approximately 425,000 shares this year in open market transactions, bringing insider ownership to approximately 31% as of September 30, 2020. In our insurance business, gross written premiums and premium equivalents of nearly $1.2 billion year-to-date were up 26% over the same period last year, driven by continuing growth in specialty and warranty programs, as sales volumes returned to normal levels in the third quarter. The launch of Fortegra specialty insurance company in late September gives us the ability to write business on admitted and nonadmitted basis in specialty light commercial lines. We are currently observing a hardening market which we expect will continue in the near to medium term. Insurance margins have held stable with our quarterly combined ratio showing improvement relative to prior periods at 90.4% as our product mix shifts. Our insurance products have very limited exposure to lines of business impacted by COVID-19, such as business interruption or other similar coverages. We continue to see market volatility for the end of the third quarter and into the fourth related to continuing economic uncertainty as COVID cases have been rising in North America and Europe. Our insurance investment portfolio ended the quarter at $611 million, up 19% year-over-year, in line with our underlying premium growth. Within our investment portfolio, we take a long-term view. Therefore, variability and the timing of investment gains and losses is to be expected. We continue to maintain over 85% of our portfolio in high credit quality and liquid securities with an average rating of AA. For Tiptree Capital, operating EBITDA was $36.1 million for the first 9 months, up substantially from the prior year, driven by strong performance in our mortgage operation. Mortgage volumes were up 54% year-over-year with notable improvements in gain on sale margins. Low mortgage rates due to the Fed intervention, combined with rising home prices in certain markets, has resulted in higher refinancing mortgage volumes. In this year of market stress and uncertainty, our mortgage business has shown its strength and serves as an example of our objectives when allocating capital, namely to source scalable cash-flowing businesses, having embedded optionality, while also providing portfolio diversification to Tiptree's platform. Our shipping operations held steady, generating stable cash returns over the past year. Charter rates for bulk commodities improved in line with improving Chinese demand, while rates for product tankers normalized, falling from the higher levels in the second quarter, driven by demand for floating storage. While Tiptree Capital's operating EBITDA for the quarter was $18 million, pretax income of $9.5 million was impacted by unrealized mark-to-market losses on our investment in Invesque as a result of a decline in their stock price. Like many companies operating in the senior care, skilled nursing, and medical office sectors, Invesque's management is continuing to take positive steps to conserve liquidity, including corporate cost reductions, deferral of capital expenditures, and suspension of its dividend. In summary, we have seen a significant recovery in our business operations for the past 6 months. Despite current global economic uncertainties, we believe our diverse set of businesses and long-term view will position us to take advantage of opportunities in the fourth quarter and into 2021. With that, I'll pass it to Sandra who will take you through the financial results in more detail.

Thank you, Michael. On Page 4 of the presentation, we highlight the company's key financial metrics. Net income before noncontrolling interest for the quarter was $14.7 million, an increase of $15.7 million over the prior year, driven by stable and continued growth in our insurance business and strong performance in our mortgage operations. Excluding investment gains and losses, revenues for the quarter were up 17%, driven by improvement in insurance top-line results, including contributions from our warranty acquisition. Operating EBITDA for the quarter was $31.9 million, up 84% from the prior year. Year-to-date, that same metric was $69.9 million, up 64% compared to 2019. The growth in both periods was driven by the same factors that supported improvement in net income. On the bottom of the page, we show a walk from operating EBITDA to total pretax income, highlighting the key differences between the two metrics. Book value per share at the end of the third quarter was $10.36, an increase of 4.3% versus the prior quarter, primarily due to our strong operating performance for the quarter. Our capital and liquidity position remains strong with cash and equivalents of $103.5 million as of the end of the third quarter, $72.4 million of which is outside our statutory insurance companies. On Page 5, we have updated our KPI trends. Operating EBITDA grew organically 80% in the quarter and 59% year-to-date. While much of the growth is being driven by the mortgage business, our insurance business continues to show stable and positive earnings performance. The growth in our insurance business can be seen in premiums and premium equivalents. As a reminder, much of the growth in this metric ends up on the balance sheet as GAAP recognizes the revenue over the life of the contracts. Year-to-date, premium and equivalents were up 26%, led by the acquisition of Smart AutoCare and the growth in light commercial and other specialty programs. Additionally, deferred revenues and unearned premiums, which represent future earnings potential, stand at $1.15 billion, up 46% year-over-year, driven by 20% organic growth and the acquisition of Smart AutoCare. Turning to Page 6. We highlight our capital allocated between our insurance business and Tiptree Capital along with their respective returns to assist investors in understanding Tiptree's enterprise value. We evaluate our return on capital using operating EBITDA which, for the latest 12-month period, was $90.8 million, up 53% from the latest 12-month period ending Q3 2019. Our operating return on invested capital of approximately 16.5% is driven by a 16.6% return in insurance and a 25.8% return in Tiptree Capital. The key drivers for the period were growth in underwriting income and fee revenue in warranty service contracts and in light commercial specialty programs, positive contributions from mortgage and shipping operations in Tiptree Capital and reduced corporate expenses, driven primarily by lower incentive compensation. With that, let's turn to our insurance company results. For the first 3 quarters of 2020, improvement in sales volume was driven by growth in warranty, light commercial, and other specialty programs. Year-to-date, gross written premiums and equivalents were $1.2 billion, up $239 million, of which $148 million was incremental from our acquisition of Smart AutoCare. In the third quarter, warranty programs grew substantially, up $82 million from the prior year. Excluding the acquisition, warranty premiums were up 16%. Specialty and light commercial programs were up $38 million or 86% over the third quarter of 2019. Net written premiums decreased by $56 million, primarily driven by softness in consumer credit and the seeding of certain credit protection business at the end of 2019. For the 9 months, underwriting margin was up $22 million or 21%. Our combined ratio improved to 91.8%, demonstrating our ability to continue to grow profitably in our insurance business despite the current economic headwinds. We continue to expect future growth to come through our vertically integrated warranty offering and specialty programs. As part of our overall plan to increase financing capacity to support that growth, in October, we refinanced our asset-based premium finance facility, extending the maturity for 3 years and upsizing the amount to $75 million. This complements the refinancing of Fortegra's revolving credit facility completed in the second quarter. Turning to the investment portfolio on Page 9. Our net investments grew by $97 million year-over-year, up 19%. $527 million of the portfolio or 86% is held in liquid, highly rated fixed income securities or cash. The average rating on that portion of the portfolio is AA which we believe provides excellent strength to our capital base despite the current volatile markets. For the quarter, net portfolio income was $2.9 million, up $0.7 million, driven by the growth in the portfolio. While we saw recoveries in certain of our portfolio securities in the third quarter, the low-interest rate environment will continue to impact net interest income. For the 9 months, net portfolio loss was $14 million, driven by unrealized and realized losses of $22 million on equities and other securities in the portfolio, $13.8 million of which was related to Invesque. On Page 11, we present the results of Tiptree Capital, which today consists of our Invesque shares, shipping, and mortgage operations. For the first 3 quarters of the year, the pretax loss was driven by unrealized losses on our Invesque shares, which is tied to mark-to-market based on its share price. Year-to-date, operating EBITDA in Tiptree Capital increased to $36.1 million, primarily driven by increased mortgage volumes and margins and a full quarter of operations from the vessels purchased in 2019 in our maritime shipping business. As Michael mentioned, our mortgage business has benefited from several tailwinds, including higher refinance volumes, supported by both low rates and rising home prices. Margins are 150 to 200 basis points higher than normal, driven by COVID-related capacity constraints. And lastly, we've been able to retain mortgage servicing rights at relatively low valuations, providing opportunity for value appreciation and future rising interest rate environment. Now we will turn the call back to Michael to conclude our prepared remarks.

Thanks, Sandra. Our third-quarter results have demonstrated the resilience of our operations as we have recovered positive earnings and sales trends across our businesses. Year-to-date, we have benefited from the diversification of our operations as our mortgage performance has complemented the stable and growing insurance and warranty services platform. Despite the uncertainty in the economy, our liquidity remains strong, and we've refinanced our borrowing facilities across the company, extending maturities and increasing capacity to support growth. And despite unrealized marks on our equity investments, our capital position remains strong to support our growth and objectives well into 2021 and beyond. With that, we will open the line for questions.

Our first question comes from Michael Santelli with Ancora.

It appears that you have a strong business in Fortegra within the insurance operations, which would likely trade at a favorable multiple on its book value. However, there are some challenges, particularly with Invesque. I would like to know your perspective on whether this represents a permanent loss of capital or if there is a potential for recovery. I have also spoken with Sandra about corporate expenses, which are heading in the right direction but still represent quite a significant burden for a company of your size. I'm interested in your outlook on this—are you planning to leverage it by making more acquisitions and thus decreasing its impact on the overall business moving forward? This is a somewhat lengthy question.

Thank you for your question, Michael. I'll start with Invesque. We are a minority stakeholder in the company and also sit on its Board. I will keep my comments to publicly available information since they are set to report their earnings on November 11. Invesque has made investments in senior housing, skilled nursing, and medical office spaces. Like others in the industry, they have faced challenges due to the coronavirus across their properties. According to publicly reported information, their operators have been generally performing well in terms of lease payments, with around 94% collected as of August, although some properties have been impacted by the virus. Invesque has been in the senior care business since we invested in 2010, an area we know well. Before the pandemic, the senior care sector had its own challenges. Currently, Invesque is a thinly traded stock on the Toronto Stock Exchange, which can lead to significant volatility. The management has taken crucial steps to maintain liquidity during this crisis by cutting expenses, reducing capital expenditures, and lowering the dividend. Although it isn't technically a REIT, it behaves like one, which has affected retail investment interest. Consequently, the stock has declined. From our perspective, the current stock price does not reflect its true value, but there are ongoing challenges related to the resurgence of the virus and property performance. Government assistance has aided operators in bridging financial gaps and facilitating continued payments. We will continue to invest and assess the situation as it evolves. It is important to note that the company is not currently experiencing any liquidity issues, and we believe it can endure this crisis and eventually realize its fair value. Does that answer your question about Invesque?

Yes, essentially. Let me ask another question. If they were to experience a liquidity crisis, would you consider providing capital to help them through it?

As I mentioned, that's not a concern at the moment. If it were to happen, it wouldn't likely be an issue for quite a while since their debts are well-structured, and I don't think they have any immediate obligations or covenant problems. So we would need to assess the situation if it arises. We have been a long-term investor in senior care and are familiar with the market. We would need to evaluate the circumstances and the capital involved. It's worth noting that we are not the only investors; there are other significant stakeholders who share our approach, wanting to protect and enhance the value of this investment, which we believe should be closer to its fair value compared to its current trading price. You can see that there are other large investors aligned with our views, who would prefer to see this investment move forward. Sandra, would you like to address the expenses? Before handing this over to her, I want to emphasize that our goal is to achieve growth. We have encountered market volatility, and while our shares may not trade as actively as we would like, we are keen on evaluating opportunities to buy them when prices dip. As indicated in our earlier comments, we have been purchasing shares over the years whenever the circumstances allow and when the value of the shares justifies it, whether through open market transactions or specific programs.

Michael, I think as we've spoken in the past, we do not need to add headcount at the corporate level. As a matter of fact, we have been investing in some technology, which allows us to be scalable just on the use of our people. Our main expenses are in public accounting and supporting capital investing. And we do believe that we don't need to add in either of those places and continue to scale and grow, so those expenses continue to decline as a percentage, as Michael said.

Michael, does that answer your question?

Yes. It's frustrating for us because we see no good reason for this company’s stock to trade below its book value, especially considering the valuable asset we have in the insurance business. Instead of...

Let's not overlook our mortgage business, which had an outstanding quarter and is gaining momentum. If you consider all our businesses, we see them as equally valuable. Throughout the challenges of the pandemic, we've demonstrated the resilience of our operations, which is why we hold onto them. I appreciate your observation and fully agree with it. I believe we are significantly undervalued compared to our intrinsic value and even our GAAP book value. A straightforward calculation of our earnings potential using market multiples could reveal a substantial value, indicating a clear picture of our intrinsic worth.

So how do you raise the profile of the company and the stock so that the investor community can figure this out?

We've certainly taken steps to highlight our insurance operation. We have also simplified our financial reporting into two main components: our insurance reporting and our Tricadia Capital report. Additionally, with significant efforts led by our CEO Jon Ilany, we have shed noncore, nonscalable businesses. We've made many moves to reduce our exposure to the overall credit markets and focus on capital allocation towards repeatable cash-flowing earnings. I believe we have accomplished this. Looking ahead, I hope to show differentiation through growth in book value and consistent, hopefully increasing, dividend distributions as we enhance our book value and earnings. My aspiration is that over time, people will recognize the value of our investments, the worth of our company, and will want to invest in us.

Well, we believe in the story. So hopefully others do too.

Thank you. I appreciate the comment.

The next question comes from Walter Schenker with MAZ Partners.

See the last Q&A was a perfect lead-in to my comments, which really relate to, and first, I commend management for steadily buying stock, and I complain about the company in not more aggressively buying stock. I realize there are limitations on what you can buy, but 1.5 million, I think that was the number, Sandra, I don't know exactly remember.

1.5 million shares, 1.5 million shares, to be clear. That's about $10 million, yes, not including our dividend.

I apologize for my earlier delay as I was in my car. I've been able to purchase a moderate amount of stock since there's been some liquidity and the price has remained low. I still firmly believe that the best approach for the company right now is to focus on buying back its own stock. Historically, you may have mainly responded to large blocks, but at a price of $5 with a $10 book value and other significant assets, it appears to me that maximizing the buyback in the open market, especially when the windows allow, is crucial. If that's what you're doing, then I commend you and the management team. My question is whether we are fully capitalizing on the current price levels to maximize our buyback, given the company’s overall value. It seems to me that this is the most favorable strategy we could pursue. You've just reported an excellent quarter, yet the stock is still at $5 despite being valued higher. It is what it is, but regularly buying back stock over time creates considerable value.

Yes. We share your views and would like to clarify that we purchased 1.5 million shares this year. We aim to balance retained earnings, reinvestment, and growth in areas that continue to thrive, such as our insurance business. However, when we observe the stock trading at a puzzling discount compared to both book value and intrinsic value, which we believe is significantly higher than book, we take action to buy shares. There are limitations, though. We generally make purchases through 10b5 programs, which restrict our buying ability based on volume constraints. During this time, we want to be cautious and conserve cash, especially given the ongoing pandemic. Nevertheless, we have consistently bought shares each year; for the past five years, we’ve acquired more than a million shares annually, with even higher amounts in some years. We continuously assess the balance between retaining earnings, reinvesting, maintaining dividends, and share buybacks. Over the years, we’ve repurchased around 30% of the company at a 37% discount to book value, and we will keep evaluating this moving forward.

Ladies and gentlemen, we have reached the end of the question-and-answer session. At this time, I'd like to turn the call back over to Sandra Bell for closing comments.

Thank you, Rob, and thank you, everyone, for joining us today. As in all quarters, if you have any questions, please feel free to reach out to me directly. This concludes our third quarter 2020 conference call.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.