Tiptree Inc. Q2 FY2021 Earnings Call

Greetings, and welcome to Tiptree Inc. Second Quarter 2021 Earnings Conference Call. As a reminder, this conference is being recorded.

Good morning, and welcome to our second quarter 2021 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. In addition, 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 posted on our website. With that, I will turn the call over to Michael.

Thanks, Sandra. Good morning, everyone. Our second quarter performance was a continuation of positive trends we have experienced over the past year with all businesses contributing. First half revenues of $594 million and net income of $36.6 million were both up substantially from 2020, driven by the particularly strong performance of Fortegra, our specialty insurance business; Reliance, our mortgage business; and gains on investment holdings across the company. After removing the impact of investment gains and losses, first half revenue growth was 35%, and adjusted net income of $26 million increased 51% from the prior year, both great results. Our insurance business, the Fortegra Group continues to deliver on its growth objectives while maintaining focus on underwriting discipline that has contributed to consistent results over the past several years. In the quarter, the team crossed a significant milestone with over $2 billion in trailing 12-month gross written premiums and premium equivalents. That represents an exceptional 23.8% annualized growth rate since 2017. Year-to-date written premiums and equivalents of nearly $1.1 billion were up 51% versus the prior year, driven by robust organic growth across all lines of business. Adjusted net income for the first half was $26.9 million, up 52%, driven by revenue growth and an improved combined ratio. The adjusted return on average equity was 18.3%, up 550 basis points from the first half of 2020. Once again, Fortegra's results demonstrate the attractiveness of combining a market-leading specialty insurer with a capital-light warranty business. As we look forward, we expect this performance to continue, led by growing top line and consistent combined ratio. Switching to Tiptree Capital, our three primary investments in mortgage origination, senior housing, and maritime transportation all generated positive net income for the quarter, and it is worth noting that Tiptree Capital on a stand-alone basis now has over $195 million of book value. Adjusted net income within Tiptree Capital was $14 million for the first half, up substantially from the prior year, driven by strong performance in our mortgage and shipping operations. The mortgage business had another excellent quarter, as the rate environment and home price appreciation continue to be tailwinds. Volumes were up 7% year-over-year, while gain on sale margins remained healthy compared to long-term historical averages. We believe the business can continue to deliver strong returns, particularly given the low-interest rate environment and steady demand for cash-out refinancings across the country. In addition, we have been adding to our mortgage servicing asset, which serves as a source for higher margin recapture volume and is a potential hedge in a rising rate environment. Our shipping business also generated positive results for the first half based on continuing favorable market conditions, particularly in the dry bulk sector. Overall, we are very pleased with the first half performance and believe Tiptree is well positioned for the second half of 2021 and going forward. With that, I'll pass it to Sandra, who will take you through the financial results in more detail.

Thank you, Michael. On Page 3 of the presentation, we highlight Tiptree's key financial metrics for the second quarter 2021 compared to the prior year period. Net income for the quarter was $8 million, driven by continued growth in the insurance business and positive performance in our mortgage and shipping operations. Excluding investment gains and losses, revenues were up 45% for the quarter, driven by organic growth in insurance operations, strong mortgage volumes and margins, and increases in dry bulk charter rates. Adjusted net income for the quarter was $13.1 million, representing a 13% annualized adjusted return on average equity. These strong operating results were driven by the growth in revenues as well as the consistent combined ratio at Fortegra. Book value per share of $11.59 increased by 17.9% versus the prior year. Compared to the first quarter 2021, book value per share declined by $0.04, primarily driven by legal and accounting fees associated with the preparation of the Fortegra IPO, the exchange of certain dilutive securities, and our second quarter dividend, the combination of which offset the positive earnings for the quarter. Turning to Page 4. We highlight our capital allocated between Fortegra and Tiptree Capital, along with their respective returns to assist investors in understanding Tiptree's intrinsic value. Over the last 12 months, adjusted return on average equity improved to 16%, an increase from 9.5% in the prior year. Fortegra's adjusted return on average equity for the latest 12-month period improved to 18.4% from 13.7% in 2020, driven by organic growth in the capital-light warranty businesses and commercial and personal lines programs, all while maintaining a combined ratio in the low 90s. Our mortgage business generated outsized returns on capital, driven by improvement in both volumes and margins, which have benefited from a strong housing market, both of which were partially offset by increased interest expense resulting from our upsized corporate borrowing facility completed in early 2020. Before diving deeper into Fortegra's results on Page 5, I would like to take a moment to remind everyone of the key characteristics of its business model that supports such consistent profitability and the opportunity for future revenue and earnings growth. Fortegra is a specialty insurer that focuses on underwriting small premium for risk insurance, that is underwriting programs that are more frequency exposed but do not present significant aggregation or catastrophic loss exposures. From a competitive point of view, large standard insurers who prefer to individually underwrite each transaction and touch every claim avoid small premium per risk insurance because the infrastructure and personnel costs required preclude them from underwriting profitably. Fortegra uses proprietary technology to overcome this challenge. Both our U.S. insurance and U.S. and European warranty offerings also generate a significant component of fee-based earnings, which contribute to the stable profitability. In addition, Fortegra's warranty product offerings benefit from being capital-light as a result of a combination of unregulated earnings and predictable loss ratios. As Michael mentioned, we continue to see strong momentum in Fortegra's top line results. For the second quarter 2021, premiums and equivalents increased 79% year-over-year, driven by growth in all lines of business, including admitted, excess and surplus, and warranty lines. As a reminder, particularly with respect to longer duration warranty contracts, much of the increase in this metric ends up on the balance sheet as GAAP recognizes the revenue over the life of the contracts. Deferred revenues and unearned premiums, which represent this future earnings potential, stood at $1.4 billion, up 40% year-over-year. For the quarter, underwriting and fee margin increased to $57 million, up $17 million or 44%, and the combined ratio held stable at 92%. On Page 7, we highlight the KPI trends over the past 3 years. Gross written premiums and premium equivalents have increased 37% over this period, with a 26% organic growth rate. Importantly, the combined ratio has consistently improved, moving from 93.3% in the 2019 period to 91.8% in the 2021 period. Fortegra's business model maintains strong economic alignment with its distribution network, which is important in delivering consistency in the combined ratio. Several of the underwritten programs have variable retrospective commission structures, meaning if a book of business is profitable, we will share that underwriting profitability with our agents. If it is not profitable, we reduce their commission, and the economics are rationalized. We evaluate the performance of the business using adjusted net income, which removes realized and unrealized gains and losses, purchase accounting amortization, stock-based compensation, and nonrecurring items. This metric has improved from $13.4 million in the first half of 2019 to $26.9 million in the first half of 2021, which has improved the adjusted return on equity from 10% to 18% over the respective periods. Turning to the next page. We believe the hallmarks of Fortegra's business model underlie the opportunity for consistent growth and underwriting profitability, combining underwriting revenue and unregulated fee income, which leads to more predictable cash flows and enhanced returns. This plan is executed across 3 key areas: the first 2 are admitted programs and surplus lines programs, both in U.S. insurance; and the third is balance sheet-light programs, which are warranty solutions. We believe that it is the combination of these 3 and the complementary nature of these diverse revenue streams that allows Fortegra to grow and grow profitably regardless of where pricing is in the P&C market cycle. On Page 9, we highlighted the key growth considerations. First, Fortegra has a high persistency rate with its agents, which generates a large volume of recurring revenue. Over the past 5 years, revenues have increased at a 16% annual growth rate or 12% organically. Second, we write multi-year contracts that generate significant upfront cash flow to the balance sheet and provide greater visibility into the upcoming year's revenue base. Third, new programs are added for both existing agents and from new agents. Our technology gives us the ability to identify opportunities to expand participation by our agent clients in the programs we offer to underwrite new programs profitably, given the amount of data available to us to analyze the risks and to scale volumes efficiently when we add new agent relationships. Our recently announced expanded partnerships with Badcock & More in the U.S. and Motorpoint in the U.K. are great examples of how we can add new business. Lastly, this business continues to expand geographically. We are very pleased with the opportunities in Europe where we can leverage our broad experience in the warranty space. We have a strong presence in Central and Eastern Europe and are growing into Western Europe and even the Pacific Rim. As you can see by the size of these addressable markets, we believe Fortegra has the opportunity to continue to expand its volumes and agent relationships without compromising underwriting profitability. Turning to the insurance investment portfolio on Page 10. Total investments and cash and cash equivalents ended the quarter at $815 million, up 36% year-over-year, in line with the underlying premium growth. We invest nearly 80% of the portfolio in high credit quality and liquid securities with an average rating of AA. First half net income was $6 million, net investment income was $6 million, up slightly as the overall portfolio increased in line with premiums. Net realized and unrealized gains were $12.5 million for the first half, driven by unrealized gains on equities. The capital and liquidity position remains strong at Fortegra with $288 million of stockholders' equity and a debt capacity of $200 million, both of which put the business in a solid position for future growth. On Page 12, we present the results of Tiptree Capital, which, as Michael mentioned earlier, consists of our Invesque shares, shipping, and mortgage operations. For the first half, pretax income was driven by unrealized gains on our investment in Invesque, which is mark-to-market based on its share price, in addition to strong volumes and margins in our mortgage business. First half 2021 adjusted net income in Tiptree Capital increased to $14.2 million, primarily driven by an improvement in mortgage volumes and margins and dry bulk charter rates. As Michael mentioned, our mortgage business has benefited from several tailwinds, including higher refinance volumes supported by both low rates and rising home prices. Lastly, we've been able to retain mortgage servicing rights at relatively low valuations, providing opportunity for value appreciation in the future rising interest rate environment. As of June 30, 2021, the fair value of the MSR asset was $23 million.

Thanks, Sandra. As I mentioned in my earlier remarks, we are pleased with the first half performance of our businesses. Over the past 5 years, Fortegra has increased its top line production at a 24% growth rate while delivering a best-in-class combined ratio of just under 92%. We believe these trends will continue and place a premium value on the consistency that the business generates year in, year out. The earnings strength of our mortgage business and a low-interest rate environment serves as a great example of the embedded upside optionality and diversity of our capital allocation. Within shipping, the demand/supply imbalance in the bulker and tanker market continues to play out and has benefited our business as global economies reopen. We continue to believe that Tiptree's overall intrinsic value has increased significantly and is materially greater than our current stock price would suggest. As we look forward, we believe Tiptree is well positioned to continue executing on our long-term growth objectives. With that, we will open the line for questions.

Our first question is from Jeff Bronchick with Cove Street Capital.

Just two quick questions. First on just the press release, and I know there's acquisitions, it's insurance accounting, it's a lot of things moving forward. But just as you list as of June 30 print versus year-end of the equity holdings of $200 million versus $120 million and then assets held for sale went down. Can you put a little color on that movement?

Sure, Jeff. I'm happy to answer that, and thanks for the question. Good to speak to you again. So yes, I guess the value of our equity holdings is going to fluctuate on two bases: one is if it goes down in price, and two is if we sell down the position. We're actively managing whatever equity positions we hold. And frankly, we've had stability in our Invesque Holdings over the last few quarters. So that has remained relatively stable. And we continue to work with management and invest to try to optimize value for that investment. In our insurance company float, we had a very nice reopening trade on prioritizing transportation and oil and gas sectors. As we realize significant value in those trades, we've taken steps to reduce that, as well as some public company positions we had in the shipping sector. So we've effectively just taken some profits there.

Got it. And so...

I'm sorry. Yes, Sandra. I apologize, Sandra. If you have anything you want to add to that, please feel free to add.

Yes. Jeff, one anomaly, which if you get into our footnotes a little bit more clearly, is we have a fixed income ETF position that supports our business in Europe, and that was about $93 million, $94 million of that number as of the end of the second quarter. And as Europe has grown, that ETF has also grown as a piece of the equities, and it gets accounted for its equities and mark-to-market like equities, even though it's a fixed income ETF. So that was a bit of the anomaly that happened from year-end at the end of the second quarter.

Got it. And so again, it would be fair to say that Invesque is an asset held for sale, similar to what you've spoken about in the past, long-run value maximization, but not a core holding that would continue to be correct, right?

I think that's fair to say.

Got it. I really compliment management on the call. The shipping purchase was smart, but is that something that was acquired to be resold? Or will we still be discussing your shipping position in five years? How do you view that?

We began exploring the shipping business almost five years ago, as it encompasses various industry segments that contribute to the sector. In our investment strategy, we adopted a long-term perspective, initially focusing on dry bulk and tankers. Recently, we also acquired a small U.S. shipping vessel and hold a partial stake in a paint business that supplies ships. Our goal is to engage in a diverse array of businesses, starting with asset investments while aiming to establish a management presence and capitalize on opportunities. We regularly assess the shipping business and conducted a comprehensive review recently, finding that it is meeting or even surpassing our expectations. Despite the challenges posed by the coronavirus, the tanker market experienced unexpected benefits in 2020, and now, as economies reopen, we’re seeing significant advantages in the dry bulk sector. We value our ships based on their purchase price minus depreciation, rather than the market value, and believe that dry bulk prices could rise in the current environment. We will strategically decide whether to increase our investments based on market conditions or reduce our holdings. It’s crucial for us to build a management presence in both our owned ships and those in joint ventures with third parties in the initial phase of our management development. Our strategy regarding the shipping cycle has proven correct, and we have navigated the fluctuations over the past two years successfully as we expand our management company. Looking ahead, we will make selective decisions about further allocations, but so far, we are on track with our expectations.

My last general question is regarding the Fortegra IPO attempt. Is this still open to opportunities and market conditions? Did it not work for previously mentioned reasons, and will we revisit it later? What can you share about that process?

Thanks for the question, Jeff. I'm glad to discuss it. We began exploring an IPO for Fortegra almost a year ago, anticipating that it would be ready for an IPO around April of this year. The process went fairly smoothly, and we aimed to accomplish several goals by taking Fortegra public. A key goal was to establish a platform for Fortegra’s future growth, enabling it to access capital more efficiently than what Tiptree could offer. As a specialty insurer, particularly in the capital-light warranty business, we saw it as a valuable standalone platform with a strong potential valuation that would support further growth and allow it to independently raise capital from Tiptree. We felt we could have moved forward with the IPO but chose to delay it due to market conditions and concerns about whether we were fully meeting our objectives. We are still considering the IPO, believing we can achieve our growth targets without substantial new capital, though we will evaluate any capital requirements for acquisitions or growth in the future. Currently, we feel Fortegra can continue to meet its growth goals as part of Tiptree. However, the initial objectives we set a year ago remain in our minds, and we are contemplating if and when it would be best to revisit the IPO market. This is still very much part of our ongoing discussions.

Our next question is from Walter Schenker with MAZ Partners.

I have a follow-up question. I've known the company for roughly five years since I met them at a conference. Over the past ten years and five years, my investment perspective is long-term, and my largest position has been held for 15 years. The stock has consistently traded below book value during this entire period, with a brief increase around the Fortegra IPO. Even now, it remains about 15% to 20% below book value. The idea of developing a portfolio of assets and establishing a management company, rather than simply buying and selling assets opportunistically, suggests a deeper, more committed approach to shipping. However, this seems to not be reflected positively in the marketplace, which concerns me over the long haul, not just for a few months, but over five to ten years. I'd like to hear from Michael, particularly, about how you and the Board view your commitment. While you can't speak for the entire board, I recognize you have a significant stake yourself. What is your perspective on creating shareholder value within a reasonable timeframe? I believe that if you were to sell the non-Fortegra assets, the stock price would improve significantly, possibly reaching around $20 per share due to the value of the other assets. We've discussed this before, and I’d appreciate your thoughts on generating shareholder value in a reasonable timeframe. Being in my 70s, my timeframe is much shorter than 10 years. Nevertheless, I acknowledge I'm just one shareholder.

Thank you for your question, Walter. I know many others share your concerns, and I'm glad to address it. Since our founding 14 years ago, Tiptree has aimed to have permanent capital to invest in the best and most appealing opportunities. While we are a smaller company, this gives us the chance to identify unique opportunities based on our extensive experience, particularly in financial services and hard asset investments. Our main focus, as I've mentioned frequently, has been to seek excellent management, cash-flowing businesses that are scalable and have added potential. Some of our businesses are beginning to realize this potential. Our goal is to earn returns while holding options, and our investments reflect that, including some that have recently become profitable. Our mortgage business exemplifies this. As our investments gain value or mature, we have sold assets and reinvested the proceeds. Cash is the ultimate measure of transparency, and over the years, we have occasionally returned to cash by selling investments. I'm pleased to state that our current businesses generate cash flow, and as we perform, we are accumulating more cash, which I appreciate. This will remain our focus moving forward. Regarding your point, one thing I repeatedly emphasize is that our stock price does not mirror our intrinsic value. This is evident from the Fortegra IPO. While we could have forced it through, I believe we made the right decision to delay it, and we will reconsider that in the future. The intrinsic value of our components is significantly higher than our current stock price. We aim to increase transparency around that value, whether through an IPO or asset sales as they mature, and you should anticipate us doing so in the future. As for your question, it's one I often receive: how do we bridge the gap between our trading price and intrinsic value? We see the intrinsic value and are focused on closing that gap. Recently, as part of our filings, we established a new incentive structure with Board approval aimed at substantially increasing our share price. This structure includes specific timelines for management to achieve certain targets. Our management team is highly motivated to realize this value.

Our next question is from Joe Solano, a private investor.

Can you hear me?

Joe, I hear you.

This is almost an ironic question for a stock that trades at 6x PE, but your growth is almost too good to be imagined. And again, I realize the irony there, for a stock that trades at such a multiple. But can you please help explain the very impressive growth in Fortegra right now? Unearned premiums and deferred revenue up something like 40% year-over-year is, again, for any company, even companies trading at 20x earnings, that's stellar. And can you just kind of flesh out how you guys are producing that and doing it in a reasonable and profitable fashion?

Sure. I'd be happy to answer, and I'll ask Sandra to add to my response as well. First, we have excellent management across all our businesses, not just Fortegra, and we practice effective rate management. In some of our businesses, particularly Fortegra, we are experiencing favorable conditions in the economy. Specifically regarding our mortgage business in Fortegra, this is definitely the case. As we continue to see low rates and home prices appreciating, we can expect ongoing positive performance in that area. Additionally, we are expanding our servicing book, which acts as a strong hedge and enables us to recapture high-margin business through refinancing. In Fortegra, we not only have strong management but have also made beneficial acquisitions over the past few years, especially in the warranty and auto warranty sectors. There are indeed positive economic factors affecting us, particularly regarding used cars and continued warranty options for those choosing to hold onto their vehicles instead of upgrading, which have contributed to our success. It's important to note that this sector is capital-efficient, and we've strategically acquired businesses to enhance Fortegra's overall presence. Sandra, do you want to elaborate further or add anything?

Yes, Joe, your question has two parts—how we support growth and how we do so profitably. We addressed both at a high level in our prepared remarks. On page 9 of the investor presentation, we highlighted three key components. First, the addressable markets for growth are substantial compared to Fortegra's current position, allowing us to be selective while still expanding. Our growth occurs in three ways: by adding new programs and agents, by leveraging our technology and data with our existing agents to deepen their relationships with clients, and by understanding risks, which enables us to grow their businesses profitably. Historically, this strategy has proven effective, as shown on page 7 of our presentation, where we have maintained a consistent combined ratio with minimal variation over time. This stability is due to our business model's high fee component, a technology-driven platform, and the predictable nature of claims. These factors underlie our ability to achieve profitable growth consistently.

And Joe, I think the last thing I'll say is on a consistent basis, I think you should expect that at the moment we see nothing that would inhibit or constrain Fortegra from continuing to grow as it has. So we're very excited about that business.

I understand that it may be challenging to provide a detailed answer to this question, but could you give a sense of how much of your growth is derived from increasing market share? For instance, I suspect the overall industry in your segments isn't growing at 40% year-over-year. I believe that most of your growth is organic, but please correct me if I'm mistaken. If the market isn't expanding significantly, it seems likely that you are gaining share. Is there any way to estimate the proportion of your growth that comes from market share versus overall market growth, and if you are indeed taking share, how is that happening?

So Joe, good question, and I'll say that you are correct that we certainly have been primarily growing that business organically from the acquisitions that we made. That being said, it is a large market. We're still a small player, and I think taking our market share is definitely part of the plan. And again, that goes to management, our experience, again, understanding the risks. So I would expect that you'll see are wanting and out there taking additional market share as we see opportunity. Sandra, do you want to add anything?

No, Michael. I think that's fair.

Okay. If I may ask one more question, primarily for Michael, I would like to know how you value Fortegra and what you perceive its intrinsic value to be compared to its stock price. Michael, I have two questions regarding this. First, can you explain how the IPO process helped you feel confident about the valuation, despite the fact that it didn't occur? Second, I suspect there are numerous private market transactions in this area, considering there are few publicly traded companies besides Assurant that operate within some of Fortegra's core businesses. Is there an active private market, and can you elaborate on where these assets are trading, as this may provide additional insight into your view of Fortegra's intrinsic value?

Absolutely. We learned a lot from the IPO process and recognized areas for improvement as we move forward. We firmly believe that Fortegra would benefit from having its own platform for more efficient capital raises in the future. Valuation in this sector is not overly complex, as businesses are typically valued based on a multiple of forward adjusted earnings. Over the past 12 months, Fortegra’s adjusted earnings were just below $53 million, and valuations generally focus on forward earnings, which we believe will be even higher. Multiples can range from 15 to 20 times depending on where a business stands compared to its peers, giving us an idea of the value Fortegra could have before any capital raise. We identified various self-inflicted issues to address for the future. The complexity of the offering and how the growth story was presented posed challenges. Investors were looking for evidence of growth, particularly in the E&S business, and we conducted a smaller offering which may have raised concerns about liquidity. We believe a larger offering could improve upon this. Our discussions with bankers have focused on how to enhance our approach, and we recognize the strength of our investor base. We need to ensure that bankers actively engage our investors interested in participating in the Fortegra IPO. Regarding private capital, there is significant interest from private investors post-IPO attempt who are eager to explore opportunities with us. We may seek to optimize Fortegra's capital structure more efficiently and possibly enhance an IPO with the right partner, which is common in such processes. However, executing an IPO is complex and requires the right market conditions. Ironically, we faced challenges because the market had surged just before our IPO launch, coupled with issues in the SPAC sector that affected investor sentiment. We experienced a tepid reception not due to Fortegra, but because of the overall market conditions. We are committed to improving upon these factors and will consider private capital opportunities when it makes sense. I actually believe there is ample capital available, with investors willing to invest at compelling levels that are fairly close to what we would expect for an IPO.

So you're suggesting that private market transactions in this space have been occurring in a range of 15 to 20 times forward earnings.

I don't want to put numbers on it, but I'll say there's a lot of capital being put to work right now. And look, when that capital goes to look for investments, a well-managed cash flowing, growing business in the sector that Fortegra is in with a combined ratio in the low 90s, with the prospects of an IPO in the relatively near term of the next, let's call it, a few years, I think that's a very unique investment.

Okay. And I would just chime in that the markets may not be a wash with money and eager buyers forever, right? I mean you guys are sophisticated enough to do that, but I couldn't help but chime in with that.

There are no more questions at this time. I would like to turn the call back to Sandra Bell for closing remarks.

Thank you, Joe, and thank you, everyone, for joining us today. This concludes our 2Q 2021 earnings call. Obviously, as always, if anyone has any additional questions, please feel free to reach out to me directly.

This concludes today's conference. You may disconnect your lines at this time. Thank you very much for your participation, and have a great day.