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Q3 2020 Earnings Call
Nov 23, 2020, 4:30 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Dan Callahan

Thank you. Good afternoon, everybody. My name is Dan Callahan, director of communication for GWG Holdings. Welcome to our third-quarter 2020 earnings webcast.

On the webcast with me today are Murray Holland, our president and chief executive officer; Brad Heppner, chairman of the board of GWG Holdings; and Tim Evans, our chief financial officer. Following our remarks today, we'll be taking submitted questions obtained in -- through the registration process. We've gotten a few questions we think will give you more information. But if we don't get to one of yours or if you have questions as a result of anything we present today, there'll be a context slide at the end of the presentation.

You can email us, call us, and we'll get to you the answer. Some statements on the webcast today, along with any projected financial results, include forward-looking statements that are subject to certain risks and uncertainties. Any forward-looking statements made on this webcast are made based on assumptions as of today, and we make no obligation to update them as a result of new information or future events. Our sample list of factors and risks that could cause actual results to be materially different from forward-looking statements can be found in our earnings release and in our most recent 10-Q and 10-K reports.

The webcast is being recorded and will be available on our website at gwgh.com through the investor relations tab. So, with that, I'll turn it over to our President and Chief Executive Officer Murray Holland. Murray?

Murray Holland -- President and Chief Executive Officer

Dan, thank you very much. Today, we'd like to review a number of agenda items on GWG and Beneficient's third quarter 2020. The first is an update on corporate events during the third quarter, then we will cover the COVID-19 update, Beneficient update by Brad Heppner will be about Beneficient operations. Then we will talk about Ben risk management underwriting tools that have been developed, and then review the third quarter 2020 financial metrics and results, and finish with a Q&A session.

First, we have reported strong performance in our life insurance portfolio with just under $40 million of maturities. This compares very favorably with prior quarters. Continued success in raising capital through our $2 billion L bond offering, this quarter, we raised right at $115 million in L bond sales, including a $43 million month in September. Beneficient closed $8.1 million in originations in October 2020 just after the quarter closed and has built a pipeline of approximately $300 million of origination sourced from RIAs, family offices, general partners, foundations, and various other sources.

The third quarter was our first full quarter with Grant Thornton as our new independent public auditing firm. We're very pleased to have Grant Thornton here, and they've done a very good job for the firm. GWG Holdings and Beneficient have taken steps to assist management in oversight of our combined company's controls. This includes engaging internationally recognized accounting firms to prepare quarterly valuations and an opinion on Beneficient's loan portfolio.

We engaged an internationally recognized accounting firm to consult with GWG and Beneficient on internal audit department developments. We've hired another internationally recognized accounting firm to review the cost basis of Beneficient financings and related loan balances. During the third quarter, we purchased a multi-year hedge to protect Beneficient's loan portfolio against potential market corrections, and we began automating our middle- and back-office functions, which will allow both Ben and GWG to scale the business, minimize costs, and increase accuracy. During the pandemic, we have experienced no material impact on the life insurance portfolio from COVID-19-based maturities.

The performance of our portfolio is not affected by market movements and is consequently non-correlated to the market. We have spent a lot of energy on focusing on the health and safety of our employees, and we are committed to our business partners, investors to continue to raise capital, pay and receive income and dividends, receive insurance policies, benefits, and otherwise meet all of our ongoing operating obligations. The majority of our employees have worked from home since mid-March. And during this time period, we've had relatively strong L bond sales in the face of this pandemic.

Next, I'd like to hand it over to Brad Heppner, the chairman of the board of GWG Holdings. Brad?

Brad Heppner -- Chairman of the Board

Thank you, Murray. Good afternoon, everyone. GWG and Ben further advanced our strategic partnership in December, 2019, nearly a year ago. And that created a joint workforce of over 150 employees.

It also expanded our strategy of providing early liquidity on professionally managed alternative assets to a vast and underserved market of mid- to high-net worth individuals and a small- to mid-sized institutions. During 2020, we have focused our efforts to build the foundation of our companies by introducing unique products, services, and systems. Some of these systems, we intend to file patents to protect. We believe all of these efforts poise our companies for 2021 to scale at a time when there's a great need for our products and services that we have created.

We believe the liquidity challenges faced by individuals and families, by small institutions and their advisors provide an opportunity for our liquidity line of products. This need for liquidity has grown substantially in the past few years, driven basically by U.S.-based investors who now hold over $3 trillion in institutionally managed net asset value of alternative assets. Now that $3 trillion excludes hedge funds that have interval liquidity, BDCs and real estate investments that are exchange traded. It's quite a large market for people needing liquidity.

Today, only 50% of these assets are held by large institutions, which have greater than $1 billion balance sheet. And that number of 50% continues to decrease. The reason for this is that the other half for the $1.5 trillion of NAV held by U.S. investors are today held by small institutions with under $1 billion in assets and by individuals and families having a net worth of over $5 million.

That's half the marketplace. And that segment of alternative asset holders is growing. There are now 2,700 small U.S. institutions that fit our category.

We all know them as small endowments, foundations, hospitals and unions. But in addition, there's $750 billion that are now held by individuals and families in our communities. This growth in our alternative asset industry and how those that hold the assets evolved over the past 15 years has required us to take a much closer look at how to deliver liquidity to different types of investors, having these liquidity needs. For example, individuals, families and small institutions, they do not have the ability to access the U.S.

intermediary markets for liquidity. That market for secondary liquidity was built for the big institutions. And, in fact, the big institutions are the ones who built the market. It is a mergers and acquisition, transactional type of market built by bankers, where each party often has their own advisors.

They have their own accounting firms and their own law firms. Typically, there are several pricing intermediaries, consultants and auctioneers in the middle of each transaction. So, it's a very expensive -- It's a complicated process, and it can often take anywhere from six to 18 months. There's a reason that individuals and small institutions cannot get liquidity out of alternatives from that market.

It's simple. They just can't afford it. It's too expensive. They need it to be simpler.

They need it to be much more rapid. They need the liquidity now for their life changes. Individuals have health needs. They have a family that needs business needs and state planning requirements.

All the big institutions, they don't have those needs. So, we went to work a few years ago to create a line of business products and services that simplifies the entire transaction for gaining liquidity, simplifies the process into a rapid and cost-effective manner to provide individuals and small institutions with access to liquidity when they need it, much easier than the big institutions that built their market for providing them liquidity. Our strategy is very simple. We're a financial services company.

We provide private trust solutions, including a unique suite of trust and liquidity solutions. I always like to highlight that Beneficient is not an investment fund and we're not an investment advisor. Our business model is to operate as a permanent financial institution and to deploy our balance sheet with capital that's off our balance sheet to fund the liquidity needs of alternative asset investors. We operate with a lower cost of capital than our competition.

They provide liquidity to large institutions and typically have to cover their own expensive promoted profits, interest and advisory fees that they pay to their asset managers, along with seven-figure transaction costs paid to Wall Street attorneys, consultants and intermediaries on every liquidity transaction that they did. They typically raised money from private equity institutional investors who have a very high rate of return expectation. Our companies, on the other hand, do not have all of these costs for managers, lawyers, outside investors. The reason is we do all of these functions ourselves inside our companies.

This means that our costs are substantially lower than our competition, often more than 50% lower than the secondary liquidity providers' cost of capital. Our asset-based lending arm operates similar to how a bank operates. And we found other ways to cut costs associated with delivering liquidity to our underserved market of individuals and institutions. All of these cost cuts allow us to operate at a spread and to be transparent to our investors on what that spread is and what we intend to earn by providing liquidity to the investors.

The benefit of our lower cost of capital, of our lower execution costs and of our lower holding costs opens us up to a market that needs our products and services and allows us to be among the first to this market with a compelling and valuable liquidity solutions and services built specifically for them. To engage with our targeted clients, Beneficient built during the 2020, the AltAccess proprietary online secure platform portal. We developed it to do business directly with our clients all online. Our clients can simply and rapidly complete all of their transactions online over our AltAccess platform.

It's our very own main street for connecting Beneficient to our target market worldwide without a brick-and-mortar presence, without the expensive legacy information technology needs or without having the burden of branch bank technology operations. Through AltAccess, clients can learn about our liquidity products and solutions, those solutions that provide cash, securities, or a mix of cash and securities, and then they can transact on those solutions from beginning to end all online. Everything can be done simply from their own system online. In the summer of 2020, Beneficient officially launched its suite of liquidity solutions for our target markets and we launched it under GWG.

Central to our launch was the introduction of the liquidity bond. It's a 506C offering, which allows our companies to advertise and promote our products to our credit investors who need liquidity from their professionally managed alternative investments. Very few liquidity providers can directly advertise and promote in the manner that we can to our target market. Since June of 2020, we have over $100 million of private assets that are currently pricing or being actively under consideration with an additional $200 million of potential transactions that are waiting on actions from our potential clients.

That's a large pipeline. This pipeline of potential new transactions has all been sourced from registered investment advisors, family offices, alternative asset sponsors, foundations, and other types of investors. Very happy to see the development of the inflow for a demand from Beneficient to provide liquidity. We should see more closings begin to evolve over the next few months.

With that, I'm going to hand it back to Murray, the CEO of GWG. He's going to talk about some of our key proprietary tools that we've developed to operate and further enhance our business. And then he's going to introduce Tim Evans, our CFO, to discuss our financial results for the third quarter. I appreciate your time today.

Thank you. Murray.

Murray Holland -- President and Chief Executive Officer

Brad, thank you very much. I'd now like to share with you Ben's risk management and underwriting tools that have been implemented here in the third quarter of 2020. First is TotalAlt. TotalAlt was developed by Ben's risk management team.

It's a comprehensive portfolio management system. It was designed and built to maintain a risk optimized collateral portfolio by employing and synchronizing accepted principles of diversified portfolio construction, using alternative asset valuation, methodologies, and hedging strategies to manage the quality and makeup, as well as the risk profile of Ben's collateral portfolio. Underwriting has developed the AltRating system. It's an original grading system built by Beneficient's Underwriting and Risk Management teams to analyze and review new and existing loans.

It's tailored specifically to evaluate loans that are collateralized with alternative assets. It evaluates various loan metrics using internally generated simulation models to create a rating score, reflecting the probabilistic risk of default for each loan. Next, I would like to introduce Tim Evans, our chief financial officer. Tim?

Tim Evans -- Chief Financial Officer

Thanks, Murray. Happy to be here to go through our Q3 results for 2020. We'll start off with our 2020 financial metrics review, then we'll move over and talk about our balance sheet and liquidity, and we'll end with a discussion of both the Ben collateral portfolio and the life insurance portfolio, Let's go ahead and start with our 2020 financial metrics review for Q3. So again, we see we have total assets in excess of $3.6 billion and stockholders' equity in excess of $400 million.

So, from a balance sheet perspective, still in line with where we were last quarter. And as we switch over here to our income statement metrics, we'll be able to discuss some of those differences that we see from Q3 2020 versus Q3 2019. So, for Q3 2020, we had gross revenue of $28.5 million, up $6.5 million from Q3 of 2019. Total expenses were up by about $38.4 million.

And income and other expenses, really other expenses here, up $22.4 million. Total net loss for the quarter of $43.5 million, more than we had in Q3 of 2019. And earnings per share similarly with a $2.23 earnings per share loss for the quarter. Let's break down what constitutes some of these differences for the quarter.

So, if we look at the $6.5 million increase in gross revenue, what we see is that this is really being driven by higher interest income and higher trust services revenues totaling about $13.6 million for Q3. Now, remember that this is comparing Q3 of 2020, where we're now consolidating these revenue items from the operations event back to Q3 of 2019, where we were not consolidating them. So, we have this new revenue stream that we're showing here in Q3 2020 we didn't have last year. Another difference is that we are not currently purchasing life insurance policies.

So, we do not have the net gain on life insurance policy purchases that we would have had back in Q3 of 2019, and that's where we see the $3.7 million difference at the top of our section down here in the bottom. And then finally we see a $3.6 negative difference for the quarter. What's really driving that number is the portfolio hedge that Murray mentioned earlier. That hedge again is intended to protect us in case of a market downturn.

However, Q3 broadly speaking, the quality of the market had increased and so the value of that hedge had decreased slightly. But again, the idea is that, over time, if the market were to decline, the value of that hedge would increase and in a way that would be sure that the collateral portfolio, Ben, was protected from any of those equity market needs. On the expense side, we did have significantly more expenses for the period, large part of that coming from higher interest of $12.5 million period-over-period. And that also makes sense because we have more outstanding L Bonds in Q3 2020 than we had in 2019.

So, we would expect to see a higher interest expense. We also have large-amount debts directly attributable to higher employee compensation. Really want to stress though this is more of the non-cash equity compensation that was issued by Ben kind of given its start-up nature and the fact that it has a number of long-term employees that are getting significant investing into their equity grants that we do not expect to see in the future. This is the last quarter where we would expect to see any of these long-term grants coming into place and setting a large non-cash expense.

But just like the ones we saw earlier this year, these are non-cash in this period that would not turn into any cash -- anytime in 2020, and just would start to -- in small amounts in 2021. So, we don't expect to have any more of these large non-cash equity compensation expenses hitting for the remainder of 2020, or going into the future. All we would expect to see is that with any new hires and that would have any equity grants that they would start adding to the overall schedule, and then the expected period over period, vesting of previously issued equity compensation. We also had higher legal expenses for the period $5.2 million, as we continue this transitionary period that GWG and Ben are in.

And we also had a recapture provision for loan losses of negative $5 million. So, what that resets is the fact that in our prior period, we had taken an expense for a potential loan loss related to one of Ben's financings. But based on changes in the underlying collateral, the value of that loan has actually increased by $5 million because we recapture that loss from the prior period because we now think it will be repaid. So that's a review of our metric summary.

Now, we move over to the balance sheet. From the balance sheet side, not a lot of changes here. We still have assets in excess of $3.5 billion, again for the period, $3.63 billion. And on a liquidity standpoint, we continue to have strong liquidity compared to some of the prior quarters back in 2019.

We're down a little bit for Q3 2020, that really that's reflected in the fact that we've paid down about $50 million of debt at Ben's senior credit facility. So, while we did have a slight decrease in liquidity there, that's offset by a smaller-loan balance on the face of the financials as well. Now, we turned to look at Ben's collateral assets. This is a slide we started including recently.

We have some updated amounts here on the total number of funds and investments. And on the total amount of Ben's loan receivables, which is $227 million. We also see on the left, the stated interest rate for those loans receivable of 14% and 2.8% of annual administrative fees that Ben collects as well for its role related to the various trusts that have these finances. So, again, when we see Ben's income, which is its interest income and its trust services income, these are really the amounts that we're seeing captured on the income state.

And then we have the breakdown of that collateral portfolio, the alternative assets, the cash flows from which are collateralizing the repayment of Ben's financings broken down by geography, industry, and investment straps. Now, we look at the secondary life insurance portfolio. Again, this portfolio continues to seize in, and the cash flows off the portfolio continue to perform as we expect, and quite strong. Total portfolio face value is $1.92 billion at $9.30 with over $330 million of policy benefits with insureds that are over the age of nine.

On the benefit side, in Q3, we had just over $39 million of liquidity for the period -- maturities for the period, which was another strong quarter for the portfolio. And again, on a trailing 12 months basis, these maturities are more than covering. The premiums that are required to maintain the portfolio. So, over the trailing 12 months as of September 30, it's 220%; so more than two times the amount needed in order to cover the premiums off of the portfolio.

If we look at it on a breakdown of different policy benefits by the age of insureds, we see the amounts here. And really, if we look at that amount beginning at 85%, we see that over 85%, it's 46% of the total face policy benefits for the portfolio, or just over $880 million of benefits over age 85. And then on our counterparty risk, we continue to be very comfortable with the quality of the credit rating on all of our counterparties for the vast majority of the portfolio. So again, another strong quarter of performance by the portfolio.

So, Dan, I will turn it back now to you for questions.

Dan Callahan

Thanks, Tim. We allowed people to submit questions during registration. We received a number of good questions. Our first question is from an advisor who asks, could you comment regarding coverage of L Bonds in the event of the liquidation?

Tim Evans -- Chief Financial Officer

Sure. I can take that one, Dan. If we look at our L Bond indenture, there is a debt coverage ratio that set out there, which effectively says that the value of the total indebtedness cannot exceed 90% of the assets of the company. And so, we perform that calculation each quarter and disclosed that calculation quarterly in all of our Qs.

It's right there toward the end of the Q and this quarter as well. And for this quarter, I think we've reported a 69% debt coverage ratio, which means that the total indebtedness of the company does not exceed 69% of the value of the assets of the company as set out in the debt coverage ratio. So, I would encourage everyone to review that debt coverage ratio disclosure in the queue, which breaks down the value of the different assets and the methodology that we use for determining our debt coverage.

Dan Callahan

Thanks, Tim. One more question for you. Is the viability of life settlements progressing as expected?

Tim Evans -- Chief Financial Officer

Yes, I would say that it is. And as you may recall, back in 2018, GWG changed its portfolio evaluation methodology and began using a longest life expectancy methodology as opposed to an Average LE methodology. And what we found as a result of that is that are actual to expected a methodology, which we discussed at length in our K. So, if you want to look for actual to expected methodology in our 2019 10-K, you will see an extended discussion there that talks about how the actual performance of the portfolio is performing as expected underneath that methodology.

And that's true through Q3 as well. So again, our disclosures there, I think would give folks more information on that methodology and yes, it's still performing as expected.

Dan Callahan

Thanks Tim. Murray, what will be the future of the GWG business model?

Murray Holland -- President and Chief Executive Officer

We have been reporting since 2018, that GWG is going to be moving their investment strategy away from life settlements industry to other alternative assets through its investment in Ben. Over the last five or seven years, the life settlements businesses become highly competitive. A number of very large well-financed entities have entered the space and yields consequently on policies have been declining substantially. And in that yield has not, is not producing a big enough spread for GWG to continue in the business.

Consequently, that our investment strategy has moved to investments in other alternative assets, through the subsidiary of beneficent. And there we are experiencing as you heard earlier from Brad Heppner, we've reported in the Q, we're experiencing considerably higher yields, and we expect to continue that strategy in the future.

Dan Callahan

Thanks, Murray. Thank you, Tim, and everyone who dialed in. Again, if you didn't get your question answered, we're happy to get it to you offline. You can call or email us.

I want to thank everybody for taking time to hear about our third quarter and our prospects going forward. We hope you have a great rest of the day. Thank you, again.

Duration: 28 minutes

Call participants:

Dan Callahan

Murray Holland -- President and Chief Executive Officer

Brad Heppner -- Chairman of the Board

Tim Evans -- Chief Financial Officer

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