FedNat Holding Company
Q2 2017 Earnings Call Transcript

Published: 12 Aug 2017

[Operator:]

Good afternoon, and welcome to the Federated National Holding Company’s Second Quarter 2017 Financial Results Conference Call. My name is Charlotte, and I will be your operator today. Please note that today’s call is being recorded. At this time all participants are in a listen only mode. [Operator Instructions] Statements in this conference call that are not historical fact are forward-looking statements. Without limiting the generality of the foregoing, words such as anticipate, believe, budget, contemplate, continue, could, envision, estimate, expect, guidance, indicate, intend, may, might, plan, possibly, potential, predict, probably, pro forma, project, seek, should, target or will or the negative thereof or other variations thereon and similar words or phrases or comparable terminology are intended to identify forward-looking statements. The matters discussed on this call that are forward-looking statements are based on current management expectations involving risk and uncertainties that may result in these expectations not being realized. Actual events, outcomes and results may differ materially from those that are -- from those what is expressed or forecasted in forward-looking statements made on this call due to numerous risk and uncertainties including, but not limited to, the risk and uncertainties described in this conference call, our press release issued yesterday and other filings made by the company with the SEC from time to time. Forward-looking statements made during this conference call speak only as of the date on which they are made, and Federated National Holding Company specifically disclaims any obligation to update or revise any forward-looking statements to reflect new information, future events or circumstances or otherwise. Now at this time, I would like to turn the conference call over to Michael Braun, Chief Executive Officer and President of Federated National Holding Company. Please go ahead, sir.

[Michael Braun:]

Good morning. Thank you for joining us as we discuss the second quarter financial results for Federated National Holding Company. Yesterday afternoon, we reported second quarter net income of 4.9 million. These results include 2.8 million in claims, net of reinsurance related to multiple weather events, including tropical storm CINDY. We had a strong quarter on the top line. Excluding realized investment gains, total revenue increased 31.9% over 2Q ‘16. That figure includes 39% growth and net earned premium in our Homeowners line of business, aided by lower ceded premiums from the termination of the 30% quota share, but more importantly, boosted by a 10% growth in earned premiums. Our distribution continued to perform well, and our products continue to be well regarded in the marketplace. We completed several initiatives in the quarter that I’d like to comment on briefly. First, we finalized our excess-of-loss catastrophe reinsurance program, including the purchase of reinstatement premium protection for additional events on all of the privately placed non-FHCF layers in our reinsurance program. You can reference our 8-K filed on July 3 for detailed information on the program. Second, we replaced our 10% Florida homeowners quota share treaty with a new treaty, meaning obtaining the 10% session level. Third, we have taken actions to improve the underwriting results in our Automobile line of business, including the termination as of June 30 of two programs that were not performing to our expectations. Of our three active programs, two have had rate increases taking effect July 1, including 8% in Texas and 25% in Florida. The third program was launched in the first quarter as adequate rate and is performing well. Fourth, we continue with our previously announced share repurchase program, deploying 6.2 million of capital in the quarter. In our Florida homeowners line of business, our 2016 statewide rate average rate increase of 5.6% is fully reflected in our premium as of the third quarter and our additional statewide average rate increase of 9.9% took effect for new and renewable premium on August 1st. As a company, we strive for accessibility and transparency with the investor community. To that end, we are pleased to be able to enhance our disclosures with this quarter, via the presentation of our results on a line of business basis. I’ll now turn the call over to our CFO, Ron Jordan, to talk through the numbers in a little more depth, as we discuss the line of business information. After Ron’s remarks, we will open up the call for questions and answers. Ron?

[Ron Jordan:]

Thanks Mike. Good morning, everyone. I’ll make just a couple of brief comments on the numbers and then provide some backdrop on the line of business information that we have provided this quarter. As Mike has already stated, our 2Q ‘17 net income was $4.9 million, which equates to $0.37 per diluted share. Turning to losses and expenses, we had $2.8 million of weather or $0.14 per share in the quarter as well as $3.1 million of prior year development, a deduction of another $0.15 per share. $1.7 million of the prior year development pertain to the homeowners and 1.45% from the auto line of business. On expenses, compared to the second quarter of ‘16, commissions and other underwriting expenses were up due to the termination of the 30% quota share treaty last June. Otherwise, expenses were generally in line with premium growth. Our second quarter results, as reported on a GAAP basis, represent an annualized ROE just short of 9% at 8.9%; excluding weather and prior year development, if one is inclined to adjust for those items as well as adjusting for $0.13 worth of net realized investment gains in the quarter, that result would be $0.53 per share in the quarter and an annualized ROE just short of 13% at 12.8%. We are also providing a 2% dividend yield at the moment based on our $0.08 a quarter of dividends. Turning my attention to the line of business information that we have provided. Let me first express my appreciation to Erick Fernandez, our Chief Accounting Officer and the entire finance team for all their efforts to enable this increased disclosure. The team has been working towards this outcome for some time now and it is no small accomplishment to implement line of business reporting for the first time, particularly when one considers all the internal control implications for a public company under Sarbanes-Oxley. As you have no doubt noticed, in the line of business information, we have taken an underwriting gain/loss approach to disclosing Homeowners and Automobile, leaving net investment income and realized gains/losses in the other line of business. As detailed on the first page of our release, the segments -- not the segments, the lines of business are defined as follows

[Michael Braun:]

Thanks, Ron. Operator, with that, I would be glad to take questions please.

[Operator:]

[Operator Instructions] Our first question comes from the line of Arash Soleimani from KBW.

[Arash Soleimani:]

So to just confirm, what exactly are the income streams from auto? Is that besides the ceding commission that you get? Is there any other income stream that you are getting?

[Ron Jordan:]

Yes. We’re in a 5% administrative fee off of the written premium from the program. And then there is also a 5% claims handling allowance that helps us with the cost of handling the claims for the total program.

[Arash Soleimani:]

And what’s the ceding commission percentage?

[Ron Jordan:]

Well, so it matches the quota share percentage of each treaty. And our growth commission already on that business, and I apologize on having to turn a couple of pages here, is in the 19% to 20% range. So yes, so we’d be getting back 14%, 15%, assuming a 75% session rate.

[Arash Soleimani:]

So in terms of the reclassifications you did, it’s just the ceding commission that’s now offsetting expenses rather than showing up as an income line item, right?

[Ron Jordan:]

That’s right. If I go back to the comments I just made about those GAAP underwriting ratios, our prior presentation really was not helpful in terms of giving a good, accurate presentation of those ratios. We have the growth commission expense in the numerator of our expense ratio without taking credit for the reimbursement of those -- of the quota share percentage of those commissions because of presenting it in other income. By netting that ceding commission against the expense itself, we are now presenting a much more accurate expense ratio on the program.

[Arash Soleimani:]

Okay. And then -- so what about the 2 other -- so aside from the ceding commissions you mentioned, there was the 5% fee you were getting for, I guess, administering the program and there was another 5% fee that you were also getting, I think, for the claims handling. So where do those 2 pieces, those two 5% pieces show up in your current financials? Just to make sure I’m clear on that.

[Ron Jordan:]

Yes. So the 5% admin fee is predominantly what makes up the other income line that you are seeing now. So $970,000 in the quarter that pertains to the 5% admin fee. And then the 5% claims handling fee or ULAE, we call it unallocated loss adjustment expenses, that is presented in the loss ratio line off an LAE line as a ceded A&O -- ceded adjusting and other expense.

[Arash Soleimani:]

Okay. And that -- is that the piece that you used to, I guess, reflect in the expense ratio?

[Ron Jordan:]

That’s right. Several moving parts. Prior to this quarter and the historical reclassifications we’ve made, we used to present costs of our claims department in the commissions and other underwriting line. Now it is classified in the loss line.

[Arash Soleimani:]

Okay. That’s helpful. And in terms of the rate increases on auto, I think, Mike, you mentioned those in your prepared remarks. Can you just repeat what those were?

[Michael Braun:]

Yes, the one program is 25%, the other one is 8%.

[Arash Soleimani:]

Okay. So there are now two programs in total remain?

[Michael Braun:]

Two programs. The other program was in Georgia, was Q1, and we’re happy with those rates. So there are three active programs and a few programs that are in runoff. Those runoff programs really hurt us. These active programs, we have a high degree of confidence in, but we continue to monitor them, and we will make changes, including if they heat up, turn them off. But right now we’ve got strong confidence in all three of those.

[Arash Soleimani:]

Okay. I mean, when you -- I guess, based on where you stand today, all the information you had maybe three months ago, six months ago, do you feel more confident or less confident that these programs will remain? I guess, is it more likely now in your eyes that they will stay?

[Michael Braun:]

Yes, more likely. So we’ve unfortunately had a little bit of a learning curve. As I say, we’ve turned off a total of three programs, and those hurt. A couple of those programs really hurt us more than we anticipated. We’ve always handled the claims on these auto lines, and therefore, we could turn them off quicker. If there’s a problem, we want to know sooner than later. So I have more confidence in the auto programs today than I did 90 days ago or 180 days ago. There has been a bit of a learning curve. We’ve got good quality folks that are handling these claims in-house as well as the management to ensure that they are done correctly. So I’ve got a high degree of confidence in it, but we are monitoring it and those numbers need to improve.

[Arash Soleimani:]

Okay. And then based on your discussion with the reinsurers on the program, do they seem committed for the long run still or you have a different [indiscernible]?

[Michael Braun:]

Yes, the reinsurers. No, no, the reinsurers, Arash, are on those programs, but let me be clear. Not only do those programs have to perform for our benefit, they have to perform for the benefit of the reinsurers. So we’re committed to that, and we believe we are in that spot on those auto programs.

[Arash Soleimani:]

Okay. And I know you put in the release that there was some adverse development from auto and Homeowners. What was the split between auto and Homeowners?

[Ron Jordan:]

Yes. The total prior year development was 3.1 million in that split. I think I actually misspelt in my prepared remarks and said 1.7 million Homeowners. It is 1.6 million Homeowners, $1.5 million auto.

[Michael Braun:]

And with that, Arash, if I could, I would like to move to a couple of other callers, if I could ask you to circle back in.

[Arash Soleimani:]

Yes, I just wanted to note the Homeowners piece, whether that would be related. [indiscernible]

[Michael Braun:]

AOB is the driver in Florida property, clearly. So AOB has been -- for us really reared its head last year and has been very impactful in a negative way on our business. No doubt about it. So that clearly has been driving our attritional loss ratio.

[Arash Soleimani:]

But you still feel that it’s stabilized, as you said last quarter, in terms of the effects on the initial gross loss pick?

[Michael Braun:]

AOB is throughout the entire State of Florida, however, our attritional loss ratio has stabilized for the last two, three quarters, and we believe, unfortunately, rate is the answer. Unless the legislators change something, rate is the answer. We’ve taken rate in ‘16, we’ve taken rate in ‘17. I anticipate rate in ‘18 unless there are other changes.

[Operator:]

Thank you. Our next question comes from the line of Greg Peters from Raymond James. Your line is now open.

[Greg Peters:]

So if we could just step back and maybe provide some additional color around the biggest line and the principal line of business for you in the Homeowners. I know you started to answer one of Arash’s questions regarding reserve development in AOB, and I was wondering if you could use this opportunity just to give us an update outside of the Tri-County area. It seems like you are definitely running a temperature in AOB, which I guess is not surprising, but maybe you could provide some color around that? And then, Mike, also talk about what initiatives you have underway and you talk about Homeowners business in other states and maybe you could give us an update there as well?

[Michael Braun:]

Yes, thanks, Greg. In terms of AOB, clearly it’s a challenge. This is not new news to everybody, and yes, it has spread outside the Tri-County very quickly. And these contractors and attorneys have networks throughout the entire state. So for us, Tri-County is approximately 25% of our policies, and Tri-County is approximately 48% of our AOB count. So we’re getting a lot of it non-Tri-County. We’ve enhanced our processes in claims, reach out to our insurers, reach out to our agents, but clearly there is a lot of money to be had and the contracting networks and the attorneys are very robust and they have adapted and spread throughout the state. So once again, our attritional loss ratio has stabilized, up at about 36 and change, call it 36.1 roughly without weather events in there. And that’s been consistent for the last three quarters. So with that, unfortunately, the answer is rain. And unfortunately, the legislators did not do anything to help the matter in 2017, I’m hopeful in 2018.

[Greg Peters:]

So, Mike, on the -- that was an interesting statistic. 45% of your AOB claims are Tri-County. Is it -- given the trends, is it reasonable to assume that maybe that 45% will gradually go down to what the percentage market share is in your book, the 25%?

[Michael Braun:]

Yes, let me slightly change that -- the statement. It was 25% in Tri-County, 48%, four-eight, is the number of claims in our AOB, as it relates to Tri-County. That number was significantly higher a year or two ago. It’s dropped, but it’s been around 50% for the last three to four quarters, however -- so clearly, there is more instances of AOB in our Tri-County versus non-Tri-County, but also the severity of those AOB and the severity of non-AOB for that matter is greater in Tri-County than non-Tri. So I would say that the contractors are much more aggressive, as are the attorneys in Tri-County than they are in non-Tri-County. So it’s growing, absolutely. To your other question on initiatives, clearly you know about our Florida Homeowners book as the core of our company. Non-Florida, we continue to do, we are in Louisiana, Alabama, South Carolina and Texas. We have a partner, MGU, that does distribute that product. We’re very happy with them. And we think there’s great opportunities for continued growth. The irony is, is that we run into the same competition in those states that we have right here in Florida. So a lot of Florida carriers are looking to expand. And then other lines of business, you’re clearly well aware, Greg, of our auto line, and we do have CGL and flood. CGL is about $12 million, relatively flat; and flood is about $12 billion and that’s relatively flat. So we’ve paused the growth a little bit in Florida due to rate adequacy or inadequacy. We have continued growth outside of Florida, and I think the auto should be relatively flat. We want to make sure that we have that under control and are underwriting it for profitability. So those are the initiatives that we’re working on.

[Charles Peters:]

If I could just follow up. Obviously, and I know you have commented on this in the past, but provide an updated perspective around your distribution partners, including Allstate and Geico and specifically, the news of some of the new entrants coming into the market in Florida that may have A rated paper, etcetera?

[Michael Braun:]

Yes. To that Greg, I mean, our distribution is critical to us. We say that our product, our service, our claims, payments, process, our services make us a destination company. So as long as we’re competitive, we don’t have to be the cheapest, we’ve got to be competitive, we’re very comfortable we are going to get that -- we are going to win that piece of business at the point-of-sale. To your question, we’re happy with the folks at Geico and Allstate. They are 2 big partners of ours. To your statement on new entrants in the market. Clearly, there’s new entrants in the market. It’s still dominated by Demotech-rated carriers. I know there has been some noise about Allstate and State Farm trying to pick up some market share. I am not all that concerned about it. And to your point, within the Nephila product, through State National, they’re out there, we’re aware of them, but I don’t see any particular threat from them that we’re not seeing from all others in the marketplace. So the Florida marketplace is very competitive. There’s carriers always coming and going, looking for more market share, ceding market share. It’s very competitive. I don’t see anything significantly changing as we sit here today, but we continue to adapt with all new information that we receive.

[Charles Peters:]

Great. And last question, just -- Ron, I don’t think in your comments you really called out Monarch. I assume that’s in the Homeowners line. Maybe you could provide us a perspective on the performance of Monarch on a year-to-date and quarterly basis?

[Ron Jordan:]

Sure. You are right. Monarch is in our Homeowners line of business, a couple of the telltale signs there are the fact that the minority interest is in that line of business as well as the interest expense on a note that exists within that joint venture. Year-to-date -- Erick, maybe you can help me out here with -- I think, year-to-date pretax...

[Erick Fernandez:]

We are in roughly about $800,000 range year-to-date. I think the biggest item there from a Monarch perspective and it’s really part of the $3.1 million partnering development, part of that was Monarch. We did take some development related to 2016. It’s obviously a very inexperienced book at this point, but we did see paids coming up and case coming up, so we felt like we had to strengthen those reserves. And again, it was part of the $3.1 million that we quoted earlier. Of that, $600,000 was Monarch related to, again, 2016 accident year. So I think -- as we look at the performance in 2016, I think the biggest item there is the fact that we’ve had to strengthen our reserves in that book of business.

[Ron Jordan:]

And Monarch’s book is heavily Tri-County. That would be one of our longer-term initiatives is to try to diversify their book into other parts of the state.

[Operator:]

Our next question comes from the line of Douglas Ruth from Lenox Financial Services.

[Douglas Ruth:]

Could you comment about the stock buyback and how much is available still on the -- to buy back?

[Michael Braun:]

Yes, good morning, Doug. We’re at a little -- at quarter-end, about a little over $3 million is available in the current $10-million program. So the board is pleased with the buyback that we’ve done so far. We’ve been opportunistic in our ability to do the buyback, and we’ll continue to manage the capital as we need in the company. And I anticipate that we’ll continue to buy back based on the price in the market as well as the capital needs of the company.

[Douglas Ruth:]

Okay. And then in the PS [ph], you gave us a little bit of commentary. Is the relationship with Geico, is it stable, is it growing? Could you maybe offer some...

[Michael Braun:]

Yes. I think Geico is a fantastic partner. It’s not huge production that we are getting, it’s just under $200,000 a week between Florida and non-Florida. I would like to see those numbers increase, they really have not, but it’s stable in terms of the production, and I think the relationship is very strong.

[Douglas Ruth:]

Okay. And how about the relationship with Progressive? I know that, that’s a fairly new relationship. How is that developing?

[Michael Braun:]

Yes, we do have the distribution of Progressive in our non-Florida states. It’s very small production. We’d like to see that pick up, obviously, but it’s completely immaterial. Really the Allstate is the largest and then I would say Geico.

[Douglas Ruth:]

Okay. And then how about the non-Florida? Could you maybe tell us how you are working at those opportunities and where is the business? Is it coming more from 1 state than another?

[Michael Braun:]

Sure. The largest state is Louisiana, that we’ve been in there the longest amount of time. And then we also have Alabama, which is a smaller state for us. South Carolina has come on strong. We are approaching about $15 million all states and really, like I say, Louisiana is the largest, then South Carolina, then Alabama and Texas has come on in the last 3, 4 months, and we’re real happy with the production that we are seeing, and we’re bullish on what we’re writing there. So those are the non-Florida states right now.

[Douglas Ruth:]

Okay. And what about the dividend? How does the company feel about maybe raising the dividend at this point for the shareholders?

[Michael Braun:]

Well, Doug. You are well documented on your dividend policy, and I appreciate you bringing that up. I personally like a big dividend as well, but we do have to balance that with the capital needs of the company. So one of the opportunities we look at now is capital that we can deploy, is it better through the buyback or better through the dividend? Some of the institutions that I’ve spoke with in the past are looking for a dividend of about 20%. So let’s just say, if we were to make $1, they’d want to see about $0.20, which is about $0.05 or $0.25 and so on. So we’re balancing all that out and the question is how do we manage the capital and if the capital can be -- there is capital that we can deploy, I think that it’s logical that we would be able to grab shares if we’re opportunistic and the market presents that opportunity. If that opportunity is not there, I think that would put more -- I don’t know if pressure is the right word, but more pressure to increase the dividend if the market went above our opportunistic purchases. But also, we don’t want to have the dividend too high. It’s got to be reflective of sustainable earnings. Clearly, we had a good ‘15; ‘16 was very disappointing; ‘17 is coming back to where we need to be. So we don’t want to get ahead of ourselves in that dividend, but we do continuously reevaluate it.

[Douglas Ruth:]

Okay. And then my final question is, could you just talk a little bit about the state of the industry and what you see some of the other industry participants doing. And any comments that you could share with us about what you are seeing?

[Michael Braun:]

Sure. Florida is highly fragmented. It’s dominated by Demotech companies, which is about two thirds of the Florida property market. People are continuously changing rates, rules, forms, underwriting, initiatives, things like that. And we want to stay on top of that. And I think we really -- hats off to our company, the team, they provide exceptional service to our agents and to our policyholders. And once again, it’s critical that we maintain that goodwill with our distribution, our agents, so that they do want to place the business with us. So we have got to maintain competitiveness. As long as we are competitive, I am very confident that the agents will continue to place the business with us in a very positive manner.

[Operator:]

Our next question comes from the line of Samir Khare from Capital Returns Management. Your line is now open.

[Samir Khare:]

I just had some questions on the reinsurance, in particular, on the quota share that just ended in Q2. Was there any commission paid out at the conclusion of the policy term, and if so, how much?

[Ron Jordan:]

Samir, good morning. So I think, as it relates to the 10%, right, it expired July 1. As part of that, we will take back the money as it relates to the unearned premium side of it. In terms of the cash that would be sitting in the experience account piece and maybe that’s a little bit of what you are alluding to, we have not commuted that quota share. So that cash, that’s not in our possession at the moment, but when and if we commute, that’s when the money would exchange hands between the reinsurer and ourselves.

[Samir Khare:]

And what’s -- just maybe take me through the nuance of what the benefit of commuting is versus not commuting?

[Ron Jordan:]

So I think the advantage really is to see out losses, right? And to the extent and the risk that they would further deteriorate from where they are right at this moment versus the investment income side of it to have the cash kind of on hand. At this point, obviously, we’re fresh off that quota share expiring and given AOB and other issues in the industry, we felt it’s not a good time to commute at the moment, but it’s something that, on a quarterly basis, we revisit to see if it makes sense to commute.

[Samir Khare:]

And then I was surprised to see that you guys renewed the quota share in some form at the 10% level. Can you just go over why you did renew it and I guess the economics of it [indiscernible] differences and the accounting differences?

[Michael Braun:]

Yes, Samir. The old quota share did have cat, the new quota share does not have cat. And the reason we did that is there is obviously an RBC charge to our surplus when you come off the quota share. So we’re looking to manage that. There is also additional pressure on RBC based on cat-exposed property carriers that are feeling it. So we just want to make sure that we continue our partnership with the reinsurers proactively to manage our capital and manage our RBC because once again, the RBC formula has been updated, and we’re just trying to stay ahead of it.

[Samir Khare:]

And just given the limitation in coverage with the cat, how much of your Homeowners premium do you cede to this quota share? I know there is geographic limitations as well. It’s just Florida, I think. Is that right?

[Michael Braun:]

Yes, Florida and it’s a 10% quota share.

[Samir Khare:]

So do you see 10% of it or do you see less than 10% because of that limitation?

[Michael Braun:]

I’m not sure I understand the question, but it’s 10%.

[Ron Jordan:]

10% of the Florida book.

[Samir Khare:]

And then -- okay, what is the ceding commission on that?

[Ron Jordan:]

I will have to get back to you on that, Samir. I just don’t have that. There is a sliding scale around unexpected loss ratio. I think the expected is in the 30% range.

[Michael Braun:]

We will get you the ceding commission.

[Samir Khare:]

So the expected ceding commission is at 30% range?

[Michael Braun:]

No, that’s separate. He was talking -- Ron was talking about the loss ratio, but we don’t have the ceding commission here. We will get that to you.

[Samir Khare:]

And who are the reinsurers on it? Are they the same as the last 10% quota share?

[Michael Braun:]

That -- it’s Swiss Re.

[Samir Khare:]

And you guys had a small amount of cat from the quarter geographically. Were they all in Florida? Were they spread amongst your Homeowners book?

[Michael Braun:]

We had CINDY that hit Louisiana. We had some -- we had a very wet South Florida in June and July, multiple events that came through the whole State of Florida, but it’s -- I believe we have three separate events.

[Ron Jordan:]

Yes, Samir, just to break out cats. $2.8 million, as we mentioned, about $1 million came from what I’ll call the Tri-County rainstorms. This is the FNIC book. We had non-Florida tornadoes, mainly in Louisiana, roughly $1 million. Tropical storm CINDY, $560,000 there. And split -- that number is split between Florida, Louisiana and Texas. And then, finally, the Tri-County rainstorms for the Monarch book was $300,000.

[Samir Khare:]

Okay. And the -- I think, Mike, you mentioned that there is some rain in July -- Q2 to date, what are the cats?

[Michael Braun:]

It’s a couple of hundred thousand dollars, is the last number I have. I am sure that may develop a bit. That’s very preliminary.

[Samir Khare:]

Okay. And then just -- as you expand geographies with your Homeowners book, how do you make sure you don’t get hit hard by cats? It’s obviously not the quota share because that’s just Florida. So can you help me understand how you guys think about that?

[Michael Braun:]

Well, yes, I mean, that’s the challenge, right? Clearly, the opportunities for a Demotech-rated carrier are coastal areas. So I think the opportunity from Texas to Florida all the way up to Maine, we are doing it very slow. We’re well aware that others are going much quicker than we are. But we want to make sure we are writing sustainable business. Clearly, hurricanes can impact most -- a lot of that area. We’re not really inland in Louisiana, most of that business is South of 10, I-10 that is, as well as Alabama. In Texas, it’s mostly coastal, being Houston. Dallas is of concern. So we are not in Dallas. San Antonio, we’re not really looking to go there. It’s mostly along the coast. South Carolina, it’s mostly along the coast, which is obviously exposed to hurricanes, but there is some inland business there. So I don’t want to tell you we are not going to get away from hurricanes. We are diversifying along more and more coastline and there is hurricane exposure all along the way.

[Samir Khare:]

Okay. And then, are you taking any rate increases in the non-Florida Homeowners books?

[Michael Braun:]

No. There is no rate increases on the property book that I’m aware of, and we’re pretty competitive. There is some pricing pressure in Louisiana. We’re seeing some people take rate in Texas. South Carolina is competitive, but I’m not aware of any rate change at this time. We do work with a partner, MGU, so they continuously reevaluate that with us. But we think we are pretty competitive, and we’re happy with the financial results on our non-Florida book?

[Samir Khare:]

Okay. And who is doing your claims adjusting in the non-Florida state? Is it you guys...

[Michael Braun:]

We handle the -- no, we handle the claims, correct. So same story as the MGU, they’re distribution and we handle the claims.

[Samir Khare:]

Okay. And there was a question about this earlier, but with the likes of Nephila coming to Florida. Could that present an opportunity for FedNat given you guys have an MGA and you send business to other carriers that don’t quite fit your appetite?

[Michael Braun:]

Every entrant is an opportunity and a threat, depending on how you look at it. So we’re always looking for ideas that we can create more value. We think we’ve got a top-notch claims team and top-notch distribution. So opportunities could come about, but I don’t want to mislead you and tell you that we’ve got something in the works with Nephila, that’s not the case. But we are always looking at ideas to create value and monetize our distribution.

[Samir Khare:]

Okay. And what are your buybacks quarter-to-date for 3Q?

[Ron Jordan:]

In the second quarter, $6.2 million. Since July 1, we have repurchased roughly 76,000 shares in the upper $15s, average price, say $15.80.

[Operator:]

Our next question comes from the line of Anthony To from KBW.

[Anthony To:]

I apologize upfront if I missed this earlier, but relative to last quarter, has AOB gotten worse, better or roughly stayed the same?

[Michael Braun:]

Good morning, Anthony. AOB for us has plateaued for the last 3 quarters, frequency has ticked up a bit, severity has ticked down a bit, but for the most part, it’s plateaued.

[Anthony To:]

Great. And just to follow up on that. Your gross Florida Homeowners loss ratio used to be 29%, and then you took it up to 36.5% due to AOB. Is that 36.5% still where it is today or has that gone up further?

[Michael Braun:]

We’re still there, but we’re continuously reevaluating it. We have additional rate that’s helping. But we’re continuously reevaluating it. And especially in light of that, we had some development. So I’m not going to tell you that it’s dropping anytime soon, but as you know, more rate is coming through and that should lower it in due time.

[Anthony To:]

Great. That was helpful. I wanted to go back to repurchases and given that you are trading at 92% book-to-value -- I mean -- sorry, 92% of book, and that you kind of -- your growth is slowly -- is sort of slowing right now, which means you need less capital for growth. Are you looking to become more aggressive with share repurchases? And can you talk a little bit just around that context?

[Michael Braun:]

Yes. In terms of the buyback, I’m a big fan of it. I think it’s a great opportunity for us to create value with our shareholders in an opportunistic fashion. I don’t like that the price is low, but because it’s low, it does create an opportunity for us. However, we have finite capital, and we have to balance the needs of what the company needs for that capital. So it is a balancing act between the capital needed for our company, but when you don’t have the growth that we had a few years back, that lessens the need for capital. So that’s why we have been in the market significantly over the past few quarters with the buyback. I’d like to see it continue, but we do have to balance the needs of the company, the capital needs of the company, with the ability to continue to buy back.

[Ron Jordan:]

For the full year, Anthony, we’ve spent -- deployed almost $8.1 million on buyback. So I think we’ve been demonstrating that commitment.

[Anthony To:]

Okay. And lastly, within other income, I just want to clarify that it encompasses finance revenues, brokerage revenues, and then, I guess, commission income from the remaining segments outside of auto. Is that the right way to think about it or is there something else I am missing?

[Michael Braun:]

Do you mind repeating that? I missed part of the question.

[Anthony To:]

So within other income, I just want to clarify that it encompasses finance revenues, brokerage revenues and commission income from your remaining segments outside of auto. Is there something else that I am missing or is that mainly it?

[Michael Braun:]

You got it. And most of that what you -- the finance revenues, of course, are across various, all the lines of business. The brokerage and the like is in the other line of business.

[Operator:]

Our next question comes from the line of Jon Evans from SG Capital. Your line is now open.

[Jon Evans:]

This is just a follow-up from Anthony’s question. So you had that 10 million authorization, you are almost through it. I guess, should we expect another 10 million? Or can you just talk a little bit about a future authorization and what you’d need to see?

[Michael Braun:]

Yes, good morning, Jon. Clearly, when it’s trading at a discount to book, we think there is an opportunity for us to buy it back. We think that, that’s accretive immediately. And I personally would like to continue that. However, we do have finite capital, and we, at the management team and the board, continue to discuss that. So we tend to like to hold on to a little bit more capital during the wind season in case it’s needed, and as we come out of wind season, you can loosen up the purse a little bit because the volatility diminishes a bit. So yes, we have some money remaining in the current buyback. I anticipate we will continue that. In terms of authorizing a new one, there is no new decision on that at this time. We’re going to continue to evaluate it based on the capital needs of the company and an opportunity within the market.

[Operator:]

Our next question comes from the line of Ron Bobman from Capital Returns. Your line is now open.

[Ron Bobman:]

And greatly appreciate the added disclosures on the segment level. My question, not surprisingly, is the auto business and sort of the cumulative profitability. There wasn’t any money made in ‘16 in the segment, and obviously, there is some growing losses in ‘17, and I expect that you won’t make money for the fiscal year ‘17 in auto. Mike, how long do you give this business, basically the auto business, and at what, can you make -- to make a full exit?

[Michael Braun:]

I understand and appreciate the question 100%. So we had built out the auto a bit, as I indicated earlier. That is through general agents that have the distribution. Some of those general agents we are very disappointed with, we did lose money on, and we did shut those down. We do have three current lines of business open through three separate sources of distribution. I’m confident in those. I’m happy with those. The numbers appear to support it. However, it needs to generate money for our shareholders. If it does not, we will turn off those programs as appropriate. But right now, I think I’m very confident that it’s going to work, but let me be very clear if it does not work, we will turn it off. To your point of how much time will we give it, we need to see improved results over the next few quarters. This is not something that we are endlessly going to chase for the next five, 10 years auto. We think there’s an opportunity in the marketplace that we can provide our services, and we can make money, and if it’s not doing it for us, we’re not going to continue in it. But as I sit here today, I am confident we are going to make it work.

[Ron Bobman:]

Do you expect to make money over the next four quarters, cumulatively?

[Michael Braun:]

In terms of auto, I can’t necessarily answer that because once again the new programs, we think they are performing well, and we think those new programs will be profitable. When you say cumulative, there are some challenges on some of the programs that have turned off. We run the claims. That means that if there is a problem, we want it to be a problem quickly, and this is a short-tail business. So I believe, as we sit here today, the pain is behind us, but we need to demonstrate that we can make money on it.

[Ron Bobman:]

And my last question on the subject is have you presented a sort of an auto-projected plan to the Board and sort of said, hey, this is what we think the next 12 and 24 and 36 months look like from a financial perspective, a P&L perspective, that at least sort of management is being gauged by?

[Michael Braun:]

Yes, we do provide the board with updated pro formas by line of business in the company -- by line of business as well as by state. They have the same expectations that you have, which is the same expectations that I have is we need to generate profit on the auto line. That is absolutely the case. I would say that you are not the only one who is frustrated with the auto. So we have got some investment in it, we’re not going to endlessly chase it if we’re not able to generate a profit from it. But as we sit here today, Ron, I do believe we can turn a profit on it.

[Ron Jordan:]

I’d like to jump in and just clarify the answer I gave to one of Anthony’s questions, if I could. You asked about the brokerage revenue. And while we do think of our brokerage entity as being in the other line of business, with respect to their single largest dollar impact on FedNat, which is brokerage revenue they receive related to our reinsurance cat program, that revenue is in fact classified in the Homeowners line of business because it essentially represents a discount, so to speak, on the cost of the reinsurance program. So I just want to clarify the brokerage revenue on the cat program is presented in Homeowners, not in other.

[Operator:]

Our next question comes from the line of Samir Khare from Capital Returns. Your line is now open.

[Samir Khare:]

Thanks for taking my questions again. Can you talk about the programs in auto that were stopped in the last year? When they were stopped, what premium volumes they had? And if it was just the programs that were stopped or the MGA relationships that were discontinued?

[Ron Jordan:]

Sure. I can -- I will do that. We’ve had programs in Texas and Georgia that we terminated in the second half of ‘16. We don’t currently have programs with those GAs, though I don’t know that, that means we would never do business with them again in the right context. We also -- as mentioned in the release, effective June 30 or July 1, so right here in the last 30 days, we’ve terminated programs in Georgia and Alabama. We do continue to have a program with that GA. In fact, the program that was just launched in April -- I’m sorry, in February in the first quarter is with that same GA. So it was more a transition from one program to a new program with that same GA. So those are the kind of the 4 terminations. And of the 3 GAs that were involved, we are still actively working with one of them at the moment.

[Samir Khare:]

Okay. So the discontinued program that was referred to in the press release was in fact that transfer of programs, is that right?

[Michael Braun:]

Well, 2 of the programs are with GAs that are no longer with us. One of the programs, we’re not performing and has started a new program, but with the same general agent.

[Samir Khare:]

Okay. And so the states that remain are Texas, Georgia...

[Michael Braun:]

Primarily Texas and Georgia. Obviously, we have a little bit of business in Florida, which we’re statutorily required to do.

[Samir Khare:]

Okay. And what would you say the profitability of the auto book from a P&L perspective and a loss ratio perspective looked like in Q2 if it was just the continued programs?

[Michael Braun:]

Well, to that, basically we’re getting 10 points, and we need to operate that at 5 points. So that fee income, it’s my expectation we need to generate 5 points of profit on that fee income. We are generating a profit on that currently. And separate from that, the underwriting results that you are seeing in the press release do not include the MGA fee income, but the underwriting results need to stand on their own. They need to be positive for us and for the reinsurer’s benefit. So the expectation is that, that program should be in the black and whether that program runs at 90% or 95%, it needs to be in the black. It cannot run above 100%. So the expectations are that we’re going to have an underwriting profit and we’re going to have positive fee income that is accretive to earnings.

[Samir Khare:]

Okay. So would that have been accomplished in Q2 if it was just the 3 programs that are remaining?

[Michael Braun:]

I don’t know that you can say that, but I do believe, once again, the current 3 programs that we have, the good operators, with good distribution, our claims team had some growing pains in ‘16, as it relates to auto, we believe that’s been resolved. We are continuously improving that process. I feel we are okay, we will add on the programs, but once again, we’re not going to endlessly chase the program to be profitable. It needs to perform for it to continue.

[Samir Khare:]

Okay. And will Q3 and Q4 auto results have any, what I call adverse remnants of the runoff programs?

[Michael Braun:]

We hope not. We believe we’ve bitten board [ph] on that. This is short-tail business, more pain can come. But as we sit here today, we’re confident in those 3 programs that we are running.

[Samir Khare:]

Okay. And how many of the programs still have 12-month policies?

[Michael Braun:]

Well, it’s a bit misleading because some of them -- they are not necessarily misleading -- they are not necessarily annual policies, but they can be 3-month policies, and then when you non-renew them, they kind of do stretch out for a year, but they are not annual policies.

[Ron Jordan:]

And nobody -- none of the programs are issuing 12-month policies anymore. The last program that was doing that changed to 6 months or less at the beginning of the second quarter.

[Samir Khare:]

Okay. And then, I think you previously indicated that you are at scale with respect to the cost of the claims adjusting group and auto-related expenses at about $70 million of premiums, but I guess with the stopping of programs in the premium volume we see this quarter from more at about $40 million run rate. So I’m just wondering how you see the auto business continuing from here with respect to the rationalization of expenses?

[Michael Braun:]

Yes, well it depends on, once again, the marketplace, it depends on the profitability of these programs. But your question is, is the field goal [ph] from $40 million to $70 million. I think that’s a good area and an assumption of where we’re going to be. I don’t know that we are going to be at $70 million with the programs that we’ve turned off, perhaps closer to $40 million. If there is redundancy in infrastructure, we will adjust that.

[Samir Khare:]

Okay. And just with respect to actual loss trends that, I guess, the industry has been seeing -- you guys have been seeing some of that as well in the auto book. Can you talk about your loss trends and what you’re seeing now if the -- if loss trends are accelerating in a negative way or stabilizing or moderating some?

[Michael Braun:]

These are very new programs, young programs with immature data, so it’s hard to say that. We don’t have years of losses that we can look at and see how it’s moving, but clearly, the industry is seeing certain things that we’re all aware of, primarily distracted driving and increased repairs on vehicles due to a lot of electronics. So we see that as well, and we’re building that into our assumptions, as we price the programs.

[Samir Khare:]

Okay. And finally, if you wanted to get out of the business, the auto business altogether today, what would be involved? How long will it take you to run off the business and what would the costs associated with it be?

[Michael Braun:]

Well, the distribution is through general agents, 3 different lines and we’ve got the adjusting staff here, so I don’t think it would be a big runoff expense. It’s needed.

[Samir Khare:]

Okay. And there is a tail to the business, a statutory tail...

[Michael Braun:]

Sure, there is a tail, absolutely, and we have the skill set. We’ve got an adjusting team of about 200 folks, and we think that we could utilize people as best we can for any runoff of auto. So I mean theoretically you can have an auto claim years -- many years later, but we can cross-train and cross-utilize the folks as best we can.

[Operator:]

Thank you. At this time, I’m not showing any further questions. I would like to turn the call back over to Michael Braun for any closing remarks.

[Michael Braun:]

Thank you. As always, we appreciate the hard work of our entire team at Federated National and the trust that our partner agents and policyholders have placed with us. So thank you for taking the time this morning, and remind our investors to always feel free to reach out to Ron, Erick or myself with any questions that anyone may have. And everyone have a great day. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day.