LRE.L - Lancashire Holdings Ltd

[twacowfca]

They recently increased their shares to buy Cathedral and they still are likely over capitalized and should be paying another nice special dividend next month or December barring a large catastrophe in the next four weeks.

 

 

Twacowfca,

 

Assuming we get through hurricane season unscathed, what level of special dividend do you expect? 

Also, can you shed some light on how management thinks about capitalisation and what is deemed excessive?

 

Thanks

 

One big advantage of de risking their business, as we have discussed, is that the rating agencies now require less capital be held as a cushion to support claims.  About half the funds needed to buy Cathedral will be provided by the previous surplus on Lancashire's balance sheet, the rest by the private placement of stock issued a few weeks ago. 

 

They don't like to cut things too close.  Therefore, I suspect any special dividend they may declare in a few weeks, perhaps on November 6, 2013 when they announce Q3 results, will be substantial, but no more than the lower end of the range of the large special dividends they have paid. :)

[WhoIsWarren]

One big advantage of de risking their business, as we have discussed, is that the rating agencies now require less capital be held as a cushion to support claims.  About half the funds needed to buy Cathedral will be provided by the previous surplus on their balance sheet, the rest by the private placement of stock issued a few weeks ago. 

 

They don't like to cut things too close.  Therefore, I suspect any special dividend they may declare in a few weeks, perhaps on November 6, 2013 when they announce Q3 results, to be substantial, but no more than the lower end of the range of the large special dividends they have paid in the past. :)

 

Twacowfca, thanks that's very helpful.

 

How do you figure the level of dividend?  Are there any financial metrics you use as a guide to judging the level of over-capitalisation?  Premiums-to-surplus (for all its flaws)? Or is this from discussions with the management?

 

I'm constantly amazed by your level of knowledge of this stock and the industry! How did you hear that Cathedral was half funded by surplus capital? I hadn't realised management had said that....

 

And on the point of surplus capital, has Cathedral's surplus capital been quantified yet?

[twacowfca]

One big advantage of de risking their business, as we have discussed, is that the rating agencies now require less capital be held as a cushion to support claims.  About half the funds needed to buy Cathedral will be provided by the previous surplus on their balance sheet, the rest by the private placement of stock issued a few weeks ago. 

 

They don't like to cut things too close.  Therefore, I suspect any special dividend they may declare in a few weeks, perhaps on November 6, 2013 when they announce Q3 results, to be substantial, but no more than the lower end of the range of the large special dividends they have paid in the past. :)

 

Twacowfca, thanks that's very helpful.

 

How do you figure the level of dividend?  Are there any financial metrics you use as a guide to judging the level of over-capitalisation?  Premiums-to-surplus (for all its flaws)? Or is this from discussions with the management?

 

I'm constantly amazed by your level of knowledge of this stock and the industry! How did you hear that Cathedral was half funded by surplus capital? I hadn't realised management had said that....

 

And on the point of surplus capital, has Cathedral's surplus capital been quantified yet?

 

The term: "surplus capital" wasn't a term they used because being over capitalized in the view of the rating agencies is not necessarily the same as "surplus", as that term may be defined by different state regulators in the US.  The point is that Lancashire has held capital amounting to more than double the amount of its annual premiums as cushion for large loss events, especially super cats.  Now, with risk as measured by their PML's down to about 60% of the level a couple of years ago, a substantial part of their capital in the view of the rating agencies is no longer necessary as a cushion to support claims.

 

Cathedral has more "capacity" allowed by Lloyd's than they have used.  This could give Lancashire optionality to return some of their capital to shareholders in the future, or even better, to write nicely profitable additional business that the staff at Cathedral or Lancashire may have the opportunity to select.  :)

[giofranchi]

Thank you twacowfca!

I do believe LRE will go on paying special dividends in the future, but don’t you think the odds are they will wait at least 2 or 3 quarters, to resume their special dividend policy?

I guess my question is: what’s the point of raising capital in the market through new stocks issuing, when barely 3 months later a special dividend is announced? Wouldn’t it have been much simpler to use the excess surplus to purchase Cathedral, simply postponing the special dividend, and without issuing new stocks? What am I missing here?

 

giofranchi

 

[twacowfca]

Thank you twacowfca!

I do believe LRE will go on paying special dividends in the future, but don’t you think the odds are they will wait at least 2 or 3 quarters, to resume their special dividend policy?

I guess my question is: what’s the point of raising capital in the market through new stocks issuing, when barely 3 months later a special dividend is announced? Wouldn’t it have been much simpler to use the excess surplus to purchase Cathedral, simply postponing the special dividend, and without issuing new stocks? What am I missing here?

 

giofranchi

 

Expectations is the missing concept.  Their shareholder base now expects surplus capital to be paid out in dividends. 

 

When the deal to buy Cathedral was informally agreed perhaps early in the year, they almost certainly didn't know that they would have $400M excess capital to pay for the acquisition that was to close EOY because they didn't know what their loss experience would be through the rest of the year.  Therefore, it was sensible to raise capital for half the purchase price as they apparently felt they would have $200M excess capital available to fund the purchase under almost all circumstances.  Now with hindsight we may wonder why they didn't try to swing the whole purchase price themselves.

 

Their situation is analogous to BRK's purchase of BNSF a few years ago.  It's possible that BRK could have funded  the entire purchase price without diluting equity, but that would have meant leveraging up more than what a AA+ company should do or would have eaten into the minimum $20B Holdco liquidity cushion that Warren says they will hold.

[giofranchi]

When the deal to buy Cathedral was informally agreed perhaps early in the year, they almost certainly didn't know that they would have $400M excess capital to pay for the acquisition that was to close EOY because they didn't know what their loss experience would be through the rest of the year.  Therefore, it was sensible to raise capital for half the purchase price as they apparently felt they would have $200M excess capital available to fund the purchase under almost all circumstances.  Now with hindsight we may wonder why they didn't try to swing the whole purchase price themselves.

 

Ok, thank you! This makes sense! :)

 

giofranchi

[twacowfca]

SAC RE is reportedly going to be taken over by 2 Sigma, a hedge fund at a price about equal to BV.

 

It remains to be seen if Simon Burton, formerly with Lancashire, will be replaced by Brian Duperreault the former head of Marsh now consulting with 2 Sigma, who is highly respected in the industry.  That would be a little bit strange as Simon seems to have done a good job managing SAC RE.  Perhaps the reported soon to be new owner wants a change in direction.

[WhoIsWarren]

Notice of Investor Day

 

giofranchi

 

Anybody on the board thinking of going to the Investor Day?

[giofranchi]

Anybody on the board thinking of going to the Investor Day?

 

You surely already know at least 1 answer to your question, don't you? ;D

 

Cheers,

 

giofranchi

[twacowfca]

Anybody on the board thinking of going to the Investor Day?

 

You surely already know at least 1 answer to your question, don't you? ;D

 

Cheers,

 

giofranchi

 

We are skipping the annual S&P (re)insurance conference in Bermuda this year as the importance of the London market for Lancashire continues to grow.  I would like to be at their investor day, but that may not be possible.  The webinar is a good option. :)

[WhoIsWarren]

We are skipping the annual S&P (re)insurance conference in Bermuda this year as the importance of the London market for Lancashire continues to grow.  I would like to be at their investor day, but that may not be possible.  The webinar is a good option. :)

 

I'm pretty sure I'll be there myself.  If you -- or indeed anyone else -- plan to attend and fancy meeting up, let me know.

 

What has been the format of Lancashire Investor Days in prior years?  Is there a reasonable amount of time before and after the 'formal proceedings' to chat to Brindle and his managers?  Roughly how many turn up to this event?

[Stone19]

It was mentioned in this article Cheers

 

http://www.theglobeandmail.com/globe-investor/investment-ideas/strategy-lab/value-investing/fund-manager-beats-pack-by-steering-around-disaster/article15087283/

[giofranchi]

It was mentioned in this article Cheers

 

http://www.theglobeandmail.com/globe-investor/investment-ideas/strategy-lab/value-investing/fund-manager-beats-pack-by-steering-around-disaster/article15087283/

 

For what it is worth, I agree with Mr. McLean. I know he couldn’t care less… but I agree with him anyway! :)

 

Thank you for posting the article!

 

giofranchi

 

[giofranchi]

Q3 2013 Results

 

twacowfca,

any comment?

 

Thank you! :)

 

giofranchi

LRE-Q3-2013-Results.pdf

[Ian L]

Only $0.13 earnings per share.

 

Elaine Whelan, Group Chief Financial Officer, commented:

Investment markets, unsurprisingly, remained volatile this quarter and, while the US wind season was quiet, the industry was impacted by losses from the European hail storms and floods. That, combined with some medium sized energy losses, meant that from an operating perspective we had a very average quarter. However, with our August equity issuance in relation to our acquisition of the Cathedral Group, and with our strong multiple, our RoE for the quarter received a substantial boost. That, along with significant foreign exchange gains, again in relation to Cathedral, has produced an exceptional RoE of 7.4% for the quarter, bringing us to 14.7% for the year.

 

I don't like how she says RoE when a substantial part of that is referring to the equity issuance.

[giofranchi]

I don't like how she says RoE when a substantial part of that is referring to the equity issuance.

 

I thought 7.4% has been the growth in "fully converted book value per share"... Am I wrong?

 

giofranchi

[Ian L]

I thought 7.4% has been the growth in "fully converted book value per share"... Am I wrong?

 

giofranchi

 

They define RoE as Growth in Fully converted book value per share. Selling shares above book value per share does indeed increase book value per share. Maybe I am too critical, but I would have liked to see Return on Equity be defined differently to adjust for this equity issuance.

They are still clear about their operating performance.

[giofranchi]

They define RoE as Growth in Fully converted book value per share. Selling shares above book value per share does indeed increase book value per share. Maybe I am too critical, but I would have liked to see Return on Equity be defined differently to adjust for this equity issuance.

They are still clear about their operating performance.

 

Ok! Thank you! :)

 

giofranchi

[twacowfca]

They define RoE as Growth in Fully converted book value per share. Selling shares above book value per share does indeed increase book value per share. Maybe I am too critical, but I would have liked to see Return on Equity be defined differently to adjust for this equity issuance.

They are still clear about their operating performance.

 

Ok! Thank you! :)

 

giofranchi

 

I think growth in FDBV/SH adjusted for dividend issuance is the best metric for judging the value creation of a financial company.  Warren thinks so too.  Each year he publishes an update of BRK's growth in BV/SH since he took control of the company in the 1960's.

 

Lancashire reports the change in this metric each quarter.  When a company can sell shares above book value they create increased value for shareholders, provided that the use of those funds produces a good return.  I think that using those extra funds to buy Cathedral will produce at least as much value in the future as they gave up by issuing the shares.  If this is correct, the increase in BV/SH represents the creation of real value for shareholders.

 

Their purchase of Cathedral is astute.  It should be synergistic beyond the expectations of most acquisitions because it opens a new game for Lancashire, a game that no one knows how to play better than Brindle.  :)

[Ian L]

 

I think growth in FDBV/SH adjusted for dividend issuance is the best metric for judging the value creation of a financial company.  Warren thinks so too.  Each year he publishes an update of BRK's growth in BV/SH since he took control of the company in the 1960's.

 

Thanks for the opinion. I would have preferred to have a 7.4% increase in FDBV/SH as a result of profits rather than the issue of shares, though I agree that Cathedral should add a lot of value.

It is interesting that they are only returning 73% of comprehensive income for the year. I wonder if it is lower as a one off to purchase Cathedral, or if they have discovered new opportunities to allocate capital.

[twacowfca]

 

I think growth in FDBV/SH adjusted for dividend issuance is the best metric for judging the value creation of a financial company.  Warren thinks so too.  Each year he publishes an update of BRK's growth in BV/SH since he took control of the company in the 1960's.

 

Thanks for the opinion. I would have preferred to have a 7.4% increase in FDBV/SH as a result of profits rather than the issue of shares, though I agree that Cathedral should add a lot of value.

It is interesting that they are only returning 73% of comprehensive income for the year. I wonder if it is lower as a one off to purchase Cathedral, or if they have discovered new opportunities to allocate capital.

 

It's a little lower than their normal distribution, perhaps because they want to have a little more cushion around the time of their acquisition.  We might speculate that they might pay another special dividend in Q1 of 2014 as they did last year after they waited to see how claims from hurricane Sandy developed.  Or perhaps not if they see some sweet ways to deploy capital as a result of the Cathedral acquisition.

 

I listened to the special meeting they had with analysts after the earlier q3 earnings call.  I think there is plenty of capital in Cathedral for them to expand their book without drawing much from Lancashire except after a big loss event when availability of capital from Lancashire to deploy immediately would be crucial to exploit a spike in rates.  They are over reserved; they have been over capitalized and by most standards over reinsured because they have not had access to the capital markets if there should be an emergency. Their combined ratio for the year is 60 to 70%. They were profitable in 2001 and 2005 and have had a low CR in every year since they were formed. 

 

They are penny pinchers like Brindle and Lancashire.  They renew their core business by hitting the road and staying in Best Western motels as they drive from one long term Mutual client to another to visit and learn how they can serve that client better in the coming year.  The stability of the relationship a client has with Cathedral is typically very important. 

 

However, when rates are attractive, they do move out of their core to exploit opportunities, but they have not had enough capital before being acquired by Lancashire to do this in a large way .

 

Cathedral described the market after Katrina as being a huge opportunity. They were so reinsured that it was only a 2% loss for them. Immediately, all the major Lloyd's companies had to withdraw from the cat market after the hits to their balance sheets and Cathedral as a small player was the only one left standing.  By the time their private equity backer was able to raise capital, a week later, rates had dropped dramatically.

 

They have a great business. Most of the insurers they reinsure are small mutual companies with annual premiums less than $50 M. Reinsurance is essential to protect their balance sheets from a big loss. Their clients are away from the costal areas that are exposed to hurricanes. Their clients must have a reinsurer who will be there with them after a big loss which is almost always a local event not a super cat. Their cedants, usually Mutuals, are not price shoppers but place a high reliance on the stability of the relationship with Cathedral.

 

Cathedral typically underwrites only $$1M to $5M per account as the lead underwriter. I see no reason why Lancashire could not come alongside them and double the amount of coverage Cathedral  now retains on their best accounts, higher amounts of coverage that would otherwise be offered to other reinsurers.

 

This acquisition looks sweeter and sweeter for Lancashire.

[giofranchi]

http://seekingalpha.com/article/1843042-is-the-8-yield-of-lancashire-holdings-sustainable?source=email_rt_article_readmore

 

Thus, the answer to the headline question, whether the 8% yield of Lancashire Holdings is sustainable, could be "Yes, but at the current stock price there is no certainty that you will get anything else."

 

Imo 8% going forward and nothing else, meaning no growth at all, is a bit too conservative... Selling for 1.5 x BVPS, it implies a future ROE no higher than 12%... Significantly less than the track-record Mr. Brindle has created over many years of being in the business.

 

Gio

[twacowfca]

http://seekingalpha.com/article/1843042-is-the-8-yield-of-lancashire-holdings-sustainable?source=email_rt_article_readmore

 

Thus, the answer to the headline question, whether the 8% yield of Lancashire Holdings is sustainable, could be "Yes, but at the current stock price there is no certainty that you will get anything else."

 

Imo 8% going forward and nothing else, meaning no growth at all, is a bit too conservative... Selling for 1.5 x BVPS, it implies a future ROE no higher than 12%... Significantly less than the track-record Mr. Brindle has created over many years of being in the business.

 

Gio

 

Yup. Their LTM earnings yield is a little below their historical average, but that's normal for a business that will have lumpy results. Importantly, their FCBV/SH went up @ 7 1/2 % last Q. They have not yet consolidated Cathedral's results.  There is an 18 mos lag before they take a profit commission on their sidecars. Yada Yada Yada.

[Guest ajc]

An article from a few weeks back to add to what twacowfca was saying:

 

Lancashire to avoid the competition with collateralized Kinesis offering

 

"With its Kinesis Capital Management unit, and its Kinesis Re collateralized reinsurance vehicle, Lancashire Holdings aims to offer a niche product which has unique features within the alternative reinsurance capital, collateralized reinsurance and ILS space.

 

We wrote earlier today about Lancashire’s third-quarter earnings statement as it reiterated its mission to create a multiple balance sheet and capital source agnostic insurance and reinsurance platform, leveraging all forms of capital and targeting multiple markets. Its Kinesis Capital Management unit will play a key role in this mission, particularly in the management of third-party reinsurance capital.

 

Lancashire has revealed more details of its thinking surrounding Kinesis, third-party capital and the products it intends to offer during its third-quarter earnings call earlier and its investor day presentation held in London, which has just finished. Here we cover a mixture of comments from both events, and from the presentations made, which reveals more detail on Kinesis..."

 

http://www.artemis.bm/blog/2013/11/06/lancashire-to-avoid-the-competition-with-collateralized-kinesis-offering/

[twacowfca]

An article from a few weeks back to add to what twacowfca was saying:

 

Lancashire to avoid the competition with collateralized Kinesis offering

 

"With its Kinesis Capital Management unit, and its Kinesis Re collateralized reinsurance vehicle, Lancashire Holdings aims to offer a niche product which has unique features within the alternative reinsurance capital, collateralized reinsurance and ILS space.

 

We wrote earlier today about Lancashire’s third-quarter earnings statement as it reiterated its mission to create a multiple balance sheet and capital source agnostic insurance and reinsurance platform, leveraging all forms of capital and targeting multiple markets. Its Kinesis Capital Management unit will play a key role in this mission, particularly in the management of third-party reinsurance capital.

 

Lancashire has revealed more details of its thinking surrounding Kinesis, third-party capital and the products it intends to offer during its third-quarter earnings call earlier and its investor day presentation held in London, which has just finished. Here we cover a mixture of comments from both events, and from the presentations made, which reveals more detail on Kinesis..."

 

http://www.artemis.bm/blog/2013/11/06/lancashire-to-avoid-the-competition-with-collateralized-kinesis-offering/

 

Thank you for the link AJC.

 

Kinesis is  the potential "killer app" for Lancashire. It's not a commoditized retro product , but customized to meet the needs of a Bermuda - Lloyd's type (re)insurer to lay off a company's specific peak risk profile. It's a unique product that has a profit percentage potential many times higher than cheap ILW's that are deeply flawed because they have basis risk for the buyers. 

 

It's good to see that they are staying with it because it has  compelling value to the buyer that no one else is able to copy.  Elaine is rather modest in her projection of how much it could goose their ROE if it starts to gain traction.