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Third Point Reinsurance (NYSE:TPRE)
Q2 2019 Earnings Call
Aug 08, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Thank you for standing by. This is the conference operator. Welcome to the Third Point Reinsurance second-quarter 2019 earnings conference call. [Operator instructions] I would now like to turn the conference over to Mr.

Chris Coleman, chief financial officer. Please go ahead.

Chris Coleman -- Chief Financial Officer

Thank you, operator. Welcome to the Third Point Reinsurance Ltd. earnings call for the second quarter of 2019. Last night, we issued an earnings-press release and financial supplement, which is available on our website, www.thirdpointre.bm.

Leading today's call will be Dan Malloy, chief executive officer. Last night, included in our earnings press release, we announced that the Board affirmed Dan as the CEO and that he would be joining the Board of Directors effective immediately. Before I turn the call over to Dan, I would like to remind you that many of the remarks today will contain forward-looking statements based on current expectations. Actual results may differ materially from those projected as a result of certain risks and uncertainties.

Please refer to the second-quarter 2019 earnings press release and the company's other public filings, including the risk factors in the company's 10-K, where you will find factors that could cause actual results to differ materially from those forward-looking statements. 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 believe allow for a more complete understanding of the company's financial results. A reconciliation of these measures to the most comparable GAAP measure is presented in the company's earnings press release.

At this time, I will turn the call over to Dan Malloy.

Dan Malloy -- Chief Executive Officer

Thank you, Chris. Good morning, and thanks for joining our second-quarter 2019 earnings call. Today, I'll provide an overview of our financial results, followed by an update on our underwriting strategy, recent developments at Third Point Reinsurance and market conditions. Daniel Loeb, CEO of Third Point LLC, will then speak to the investment performance in more detail, and Chris will cover our financial results.

We will then open the call up for your questions. We are very pleased with this quarter's financial performance. Our underwriting results continue to improve as we see the benefits of our shift in underwriting strategy, along with improving market conditions, and we had another quarter of strong investment returns. Our combined ratio for the second quarter was 101.1%, and we are on track to achieve underwriting profitability later this year, subject to the ultimate quantum of property-catastrophe events. We generated a return on equity of 4% for the quarter, bringing our year-to-date return to 15.4%. We are pleased to report a number of positive developments during the second quarter relating to our underwriting strategy.

The buildout of our property-catastrophe portfolio has gone better than expected based on all key metrics. We were pleased with our market acceptance at the important June 1-Florida-renewal date, and we were signed on a number of well-priced accounts with top cedents. During the second quarter, we wrote approximately $16 million of property cat premium, bringing our total 2019 written in this class of business to $57 million. Our non-catastrophe business, which still represents the majority of the portfolio, continues to show evidence of improvement.

We are benefiting both from primary-pricing trends, which a number of CEOs have talked about during this earnings season, as well as improvement in reinsurance contract terms and conditions. Our new specialty lines underwriting team that joined during the first and second quarters has written more than budgeted to date. You may remember from our previous calls that their portfolio is heavily weighted to our January 1 business. And based on client and broker response so far, we are increasingly confident that we will deliver on the $20 million to $25 million of new specialty business that we expect to write during 2020.

Market conditions in these lines remain stable. Building on our new business initiatives, we recently announced that David Sinclair, a 25-year industry veteran, will be joining our London office in September. We are excited about the new business opportunities he will develop in both traditional reinsurance with a focus on Lloyd's and Europe, as well as strategic reinsurance investments, where we've already had success in taking small equity stakes exchanged for long-term access to unique reinsurance opportunities. We look forward to expanding our efforts in this area.

Our new underwriting initiatives and concurrent expansion of risk appetite require that we make changes in our investment strategy. Following an initial redemption of $350 million in May from the TP Fund, at the close in Q2, we submitted a redemption notice for $400 million, bringing our total redemption to $750 million. We have invested these amounts in high-grade, short-term fixed income investments under the management of Third Point LLC. We believe that the impact of our shift in underwriting strategy will result in a more balanced contribution for underwriting to our overall returns and will contribute to lower volatility results.

We are well-positioned to capitalize on underwriting opportunities while taking advantage of Third Point LLC's ability to outperform in managing our investments, which has always been the goal of our total return model. We expect that delivering underwriting profits will build the franchise value of Third Point Re and allow us to close the gap on our discount-to-book value as we demonstrate the full potential of our business model. We feel very good about the changes that are taking place and are confident in our ability to grow book value for the benefit of shareholders more consistently over time. I will now hand the call over to Daniel Loeb, who will discuss the performance of our investment results in more detail.

Daniel Loeb -- Chief Executive Officer

Thank you, and good morning. First, I'd like to welcome Dan Malloy as TPRE's new CEO. We've already started productive dialogue with Dan, and we look forward to working with him in the future. Third Point Enhanced LP, the Third Point Reinsurance investment portfolio actively managed by Third Point LLC, generated positive returns of 5.8% for the second quarter of 2019, net of fees and expenses.

When combined with the company's fixed income portfolio, consolidated-investment results for the quarter were 2.9%. The Third Point Reinsurance account represents approximately 18% of assets managed by Third Point. In our previous communications with TPRE's shareholders, we outlined our plans for investing in 2019 to generate alpha by concentrating on specialized strategies, where we believe we have an edge, and reduce market risk via lower-net exposures and less beta in the portfolio. Our net exposures averaged 40% throughout the year.

Considering this reduction in exposure and beta, we're pleased to have generated gains of 17.7% for TPE through June. The consolidated portfolio returned positive 10.4% during the same period. Each of our investment strategies combined to positive returns in Q2 and also for the year to-date, with equities driving 80% of the profits. As a result of our repositioning, at the beginning of 2019 and several new investments in event-driven and active situations, our equity portfolio has the highest proportion of idiosyncratic to other types of risk, such as market sector and factor in the past five years.

Our equity book return on average exposure was 7.8% for Q2 and 25.7% for the first half of the year. Gains were largely due to strong performance in core equity loan positions, especially those with an activist component. Our recently announced investment, Sony, was the largest contributor in Q2 gains. If you'd like to learn more about our position, we shared our thesis and upside case on www.astrongersony.com. In credit, corporate credit returned 1.7% on average exposure for Q2 and 3.1% for the year.

Our largest position in the unsecured debt of California utility business, Pacific Gas and Electric, has been the best performer in the portfolio so far this year. Our modest sovereign credit portfolio returned 9.1% for Q2, bringing year-to-date returns to 21%. Returns for this strategy are primarily attributable to recent investment in the sovereign debt of a Lat Am country, where we have successfully invested before. Finally, ABS also performed well, generating an ROA of 4.5% for the quarter and 7.8% for the year. As we move into the second half of the year, we believe our portfolio positioning, especially late in the economic cycle, and strategic focus allows us to take advantage of market corrections and then be prepared to shift investments across the capital structure opportunistically.

Now I'd like to turn the call back over to the TPRE management team to discuss our financial results.

Chris Coleman -- Chief Financial Officer

Thanks, Daniel. For the second quarter, we generated net income of $53 million or $0.57 per diluted share, bringing our year-to-date net income to $186 million or $2 per diluted share, which translates into a return on beginning equity for the second quarter of 4% and 15.4% year to date. Our diluted book-value-per-share at the end of the second quarter was $14.51, which was an increase of 11.8% from December 31, 2018. We generated a $2 million net underwriting loss for the second quarter, and our combined ratio was 101.1% compared to 103.6% in the prior-year second quarter.

The improvement was primarily due to a shift in business mix, including earnings on a property-catastrophe portfolio that we began writing in 2019. For the second quarter, we recorded a small net improvement in underwriting results related to changes in estimates of prior- year's loss reserves, net of the related impact of acquisition costs. We have now had 12 quarters in a row of favorable or flat prior year net impact of reserve development. Our gross premiums written for the second quarter was $83 million, which compares to $50 million in the prior-year quarter.

The increase in gross premiums written was primarily due to new contracts found in the current year period, including $16 million of new property-catastrophe business. Gross premiums written for the first half of 2019 was $402 million compared to $428 million for the first half of 2018, a decrease of 6%. The decrease in gross premiums written for the six-month period was the net effect of timing differences, contracts that we did not renew in the current year and new contracts written in the current year period, including $50 million -- $57 million of new property catastrophe business. Net investment income for the quarter was $69 million and was $224 million for the six-month period, which reflects the returns for the periods which Daniel discussed in detail. Total general and administrative expenses were $20 million for the second quarter of 2019 compared to $10 million for the prior year period.

For the six-month period, general and administrative expenses were $32 million compared to $19 million in the prior-year period. The increases were primarily due to severance costs, which are reflected as part of corporate G&A for segment-reporting purposes; higher payroll-related costs due to increasing headcount to support our underwriting expansion, as well as higher incentive plan accruals and share compensation expense, reflecting both an increased headcount, as well as improved performance to date relative to incentive targets compared to the prior-year periods. During the quarter, and thus far in 2019, we have not repurchased any of our common shares. We recognize that we've been trading at a significant discount to book value, which would make share repurchases an attractive capital management tool.

However, we are also mindful of the size of our capital base and market capitalization, and we'll continue to balance the accretive benefits of buying back shares at a discount to book with maintaining sufficient capital to support the growth of our business, as well as rating agency, regulatory capital and other considerations. We thank you for your time, and we'll now open the call for questions. Operator?

Questions & Answers:


Operator

[Operator instructions] The first question comes from Sean Reitenbach of KBW.

Sean Reitenbach -- KBW -- Analyst

Is there any way to quantify the impacts of the separation costs versus the other things driving corporate -- the total corporate G&A year over year? Or--

Chris Coleman -- Chief Financial Officer

Sure. There's about $6 million of nonrecurring costs coming through corporate G&A in the current quarter related to the separation agreement that was previously disclosed and other related costs around that.

Sean Reitenbach -- KBW -- Analyst

OK, perfect. And then is some of the elevated composition -- or compensation tied to higher retention packages for people staying at the company?

Chris Coleman -- Chief Financial Officer

No, nothing in terms of higher retention packages, but really just a function of our -- the performance criteria on our incentive compensation plans. Both on the annual cash bonus, as well as share-based compensation reflect that our returns to date of exceeded budget on both the investment side overall returns, as well as combined-ratio targets.

Sean Reitenbach -- KBW -- Analyst

OK, great. Turning to the acquisition cost ratio. It looks like there's some seasonality in the 2Q ratio. It looks like the last three years has been a little bit higher compared to the other quarters.

What's driving the seasonality there? And should it -- will it persist?

Chris Coleman -- Chief Financial Officer

Yes. It's less about seasonality. There's really -- there really isn't any seasonality to the acquisition-cost ratio. What sometimes throws off the trend line is many of our contracts have profit commission and other features that vary with loss ratio movements.

So you can have situations where you have a loss reserve development and a contract positively or negatively that's offset by profit commission movements, which is captured in the acquisition-cost line. When you adjust for those items, the acquisition cost ratio has been relatively constant over the recent several quarters, including second quarter last year. Now what you'll start to see over time, as we're shifting the mix of business toward a higher proportion of property cat and other excess loss contracts that have a lower acquisition-cost ratio, you will, over time, start to see that shift downwards, both on the loss-ratio line, subject to property cat events, of course, but also in the acquisition cost line. So really, there's -- I guess, to answer your first question, there really isn't seasonality, and it actually has been relatively consistent when you adjust for the impact of reserves.

Sean Reitenbach -- KBW -- Analyst

That's very helpful. And then for Dan, how do you assess the likelihood of a U.S. or global recession? And do you think the portfolio is positioned for that possibility well?

Dan Malloy -- Chief Executive Officer

Yes. It's a question we think about all the time, and we're looking for some indication of a recession. We really don't see it anywhere any signs of it coming up in the near term. But having said that, I mean, we recognize that it's been a long time since the last one, and the portfolio is really set up to be much more flexible with lower nets and much lower beta.

So that when one does inevitably come, we'll be ready for it. And if market downturn happens before, we'll be better positioned than we were, for example, last year.

Sean Reitenbach -- KBW -- Analyst

OK, great. And then one last one. I'll requeue. How's management -- are there any updates on PFIC developments or how management's thinking about that?

Dan Malloy -- Chief Executive Officer

Sure. I mean, as you would have seen, there's been some recently issued proposed regulations that attempt to provide additional clarification around defining active conduct with an insurance company. There's a lot of uncertainty right now with regard to how to interpret those regulations or proposed regulations on how to apply the guidance. We continue to work closely with our tax advisors and industry groups to better understand the regulations.

And at this point, it's really too early to tell exactly how it'll affect the broader industry, including us, but we're certainly paying close attention to it.

Sean Reitenbach -- KBW -- Analyst

OK. Great. Thank you very much.

Operator

This concludes the question-and-answer session. I would now like to turn the conference back over to Mr. Dan Malloy, chief executive officer, for any closing remarks.

Dan Malloy -- Chief Executive Officer

Thanks, everyone, for joining us, and I look forward to talking to you next quarter.

Operator

[Operator signoff]

Duration: 23 minutes

Call participants:

Chris Coleman -- Chief Financial Officer

Dan Malloy -- Chief Executive Officer

Daniel Loeb -- Chief Executive Officer

Sean Reitenbach -- KBW -- Analyst

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