GWG Holdings, Inc.
Q1 2018 Earnings Call Transcript

Published: 15 May 2018

[Dan Callahan:]

Thank you, and good afternoon, everyone. My name is Dan Callahan, I’m Director of Communications at GWG Holdings. Welcome to the First Quarter 2018 Webcast. On the webcast with me today are Jon Sabes, our Chairman and CEO; and Bill Acheson, Chief Financial Officer. Following our remarks, we’ll be happy to take your questions. You can do it online, open the dashboard and your screen look for the question text box and type your question in. Again, we’ll be answering questions at the end of the presentation. Some statements made on the webcast today, along with any projected financial results, including forward-looking statements are subject to certain risks and uncertainties. Any forward-looking statements made on this webcast are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. A 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-K and 10-Q reports. During the webcast, you’ll hear references to various non-GAAP financial measures, which we believe enhance understanding of our performance. Reconciliation of the non-GAAP numbers to their respective net GAAP numbers can be found in the press release available on our website. Please note that everyone but the participants are in listen-only mode, again, questions can be submitted through the dashboard text box and will be answered at the end of the presentation. Today’s webcast is being recorded and will be available on our website at gwgh.com through the Investor Relations tab. And with that, I will turn it over to Jon Sabes, Chairman and CEO of GWG Holdings.

[Jon Sabes:]

Thanks, Dan and good afternoon, everyone. Thank you for attending our Q1 2018 earnings call. Again, it feels like just yesterday, we were on the call for year-end. So again, I’m just going to make some remarks about the strategies underway and some progress, again, that we are doing in that regard. Our purpose as the company is an industry innovator. We’re focused on the life insurance secondary markets for all the reasons. Investors have been following us over the years to provide value to consumers, who own life insurance, to build a profitable portfolio of life insurance where we drive non-correlated yield. Lately, we’ve been focused on the primary life insurance market and the infusion of technology that promises to dramatically change the business. And we’re expanding our alternative assets portfolio with the BEN transaction, and I’ll cover that briefly as well. So our portfolio of life insurance policies stood at $1.7 billion in face value at the end of Q1 2018. We’ve been building this portfolio over a number of years. We have invested $644 million in the portfolio. So that leaves about $1.1 billion of gross spread that we will earn over the course of a number of years. The average age of the insurance portfolios stands at 82 years of age. We have paid out over $498 million to the consumers who have sold their life insurance policies to us. We have serviced just under 1,000 individuals now since – in this portfolio, but over the course of our business, we serviced about that many or just a little bit more. And we have delivered extraordinarily large amounts of value to those consumers we’ve served since being in business, again, we returned in excess of $458 million of cash – in excess of the cash surrender value to the seniors we’ve served. So we’re really excited about the business to provide consumers owning life insurance value-creating liquidity for them with the secondary market and building a well composed portfolio of alternative assets made up of life insurance policies. Our goal really with the secondary market going forward has been focused on origination. We’re focused on how we originate what is estimated to be $187 billion annual opportunity, the industry as a whole purchased about $1.7 billion at face value of life insurance, and so how do we do that, and again, for those of you to indent before you’ve seen this graph. We are focused on the life insurance distribution hierarchy composed of IMOs, BGAs and independent agents. We have been very successful in working with the top of this hierarchy, mainly the IMOs and BGAs. Our messages, our products, our services are being highly valued. We received thousands of policy data from these groups. And we’re right now really focused on activating this opportunity through working with the BGAs and the agents themselves. Over the last six months, we’ve been restructuring our agent and sales operations team and we’re focused on agent engagement. This quarter, we really put that into place, and we are seeing the benefits from the changes we instituted a few months ago. And as we look forward, we are going to be engaging our entire sales infrastructure to support and bring our message through the BGA network and this is a robust team of over 16 professionals, who call on agents and financial advisers throughout the country. So we think in the quarters ahead, at least throughout the balance of the year, we’ll finally get to test the veracity of originations through this distribution, it’s been hard work, but we’re making lots of progress and now at the level that we need to test out our theory on where these policies can come from. We think this ultimately adds a lot of value as we have seen competition and lots of interest from institutional investors and assets that we originate. So we think that at the end of the day, a high volume of origination business in the life insurance secondary market will be a very valuable business for the shareholders. Last, at the year-end, I reported about our life exchange annuity LEXA that is delayed. We need the partnership of an annuity provider and the carrier that we were working with has had to put us on delay. So that’s a GBD deliverable, but we’re still confident that the LifeCare Xchange that Chris Orestis has primarily been responsible for and our team in terms of showing the exchange value of life insurance nonetheless, we will be well received in the distribution, but I didn’t want to give an update on life exchange annuity. In terms of the primary market and the infusion of technology Intuit or Insurtech, again, at the year-end, I announced our mortality test, our smoking test and alcohol test. The mortality test is an all cause mortality test that is licensed from UCLA. The smoking and alcohol tests are propriety tests that we have developed ourselves. The smoking test will be able to determine if someone has a current former or never smoker as well as how much they smoked if they were or are a smoker. The alcohol test will be able to characterize people into heavy, moderate or light or never drinkers. Again, these are served to be very valuable for the life insurance industry and are more traditional to the underwriting process as opposed to the alcohol’s mortality. This year, we really focused on commercializing these three tests. We’re doing that through some R&D and a pilot. We – since our year-end call, we have officially signed our large-scale pilot that we’ve been talking about for many, many months. So that is BEN Inc. And we expect to operationalize that during the second quarter. That is a scale test to concurrently underwrite, look at people through epigenetics as well as compare that to the traditional underwriting. So this is going to be the first time we’ll see how epigenetics either replicates or add value to the underwriting process, we’ll also be testing epigenetics smoking and alcohol test against the insurance industry’s gold standard as well to determine such. So we expect these tests to – with the pilot and with some of the R&D that we’re doing in connection with the pilot, to be done this year, and we’ll stand ready to really commercialize the test with the industry going forward as we were able to produce the results that we learn from the skilled pilots. 2018, we’re going to invest around $5 million in this endeavor. That’s about split equally between people, the R&D and the pilot itself. So that will be expensed and will increase our overall G&A. We look at that more as an investment as opposed to a current expense that we can expect to get return on. Again, that team being led by Dr. Brian Chen, my brother Steve, who is a Ph.D in chemistry, Tom Nodine, Michael Curran and Randy Olson, well-known artificial intelligence machine learning expert. So that’s where we’re at like that epigenetic were super excited about where we were going to land that business toward the end of the year. We think we’ll have something to commercialize going forward. We aren’t quite done with Insurtech. We still see additional opportunities there and in that regard, again, at the end of the year, I announced that we’re going to launch a digital MGA. I showed this graph or something like it, again, at year-end call that L, that inside the graphic in between ancestry.com and 23andMe and Human Longevity and Wamberg Genomic Associates, that’s ours – where we think we see an opportunity to go directly to consumers and allow them to avail themselves to advance testing. We can give them some of the genetic or recreation entertainment as well as gives them some of the most, access to most advanced science available to them as they go through life insurance underwriting. We think this will really serve to push us to the forefront of the Insurtech among the ranks of Lemonade, Oscar, Ladder, Health IQ all well known Insurtech. That we really seeking to lay claim to as this industry undergoes fundamental change. By the digital MGA will help us apply it to the epigenetic to the underwriting of life insurance. And that’s what’s unique about this as opposed to having to work within through the carriers. We will actually have insurance applicants and begin to gather up the epigenetic signs and make that available to carriers. You can find out more information about this effort at the future of life insurance.com. There’s a great little video that talks about our journey as well as some downloads on more specifics on this effort. Again, we think this is big news as well. The Insurtech Book was published. This is an annual compendium of sort of the top thinkers and insurance industry and I was invited to write a chapter for that. So I bet published, I guess. And Dan tells me that this is the number one hot new release in the professional and investments in securities category on Amazon. So there you go. All-in-all, we think, again, this is a way for us to advance our story, much more aggressively and broadly than through a testing business that Life Epigenetics is doing. We’re still formulating our budges and some of the more specifics around that long, but we expect this business to get launched in second quarter of this year. We’ve identified professional to leave the group and we are right now playing together some key components to this business that we think will make it a compelling opportunity for consumers so that they come and avail themselves to the testing and we can work with carriers to show them the power of epigenetics to be used in life insurance underwriting. So we’re very excited about where this is going and to get again more forward in terms of the business overall as opposed to working behind and under the carriers as a testing company, so more to come on that as we move forward on our business that way. And finally, growing our balance sheet alternative assets with Beneficient transaction, again, this is a strategic relationship. We filed an 8-K recently to announce that we expect to close by the end of June. This, again, transaction provides for expensive balance sheet growth for us. It diversifies our portfolio like alternative assets, while we really like in our experts in the life insurance alternative asset class, growing that portfolio to diversify in a way gives us a more consistent earnings and cash flows, one of the criticisms that I know many investors have had with us. And I think it’s exhibited in this quarter were we had inconsistent earnings due to the lumpiness of mortality or otherwise. And as well, again, I think of the life insurance portfolio as a spring that we’re loading by paying in premiums quarter-after-quarter, and paying yield quarter-after-quarter, both of those are expensed, while we load that spring to ultimately receive the death benefit. So it’s a long-term play, so what do we do in the interim, the Beneficient transaction is a really unique opportunity to work with a top tier group of professionals. We’re experienced in the alternative asset class, a different type of alternative asset class than the life insurance portfolio, but one that can – we think greatly enhance our overall business model and complement the life insurance portfolio. As part of this transaction, as you many of you know, we are increasing our common equity as well as we’re doing it in a way that is accretive to the book value of common shareholders. And there is no change in the management or an underlying insurance-related strategies. So that all the strategy that we’re talking about we’re going to continue to execute with a bigger batter, so to speak balance sheet. And we’re really excited about that. A final thought on that is we’re looking at opportunity to distribute some of BEN’s products. They’re a preferred liquidity provider to owners of alternative assets, a different type of alternative asset then say life insurance policy. So we’re looking to bring their product to the distribution research. So that’s the BEN transaction. Look for that to close and get integrated into our earnings over the next forward-looking 12 months. And we will continue to execute the strategy that we’re talking about today. I’m going to hand it over to Bill and he is going to walk through some of the more specifics on the queue itself. Bill?

[Bill Acheson:]

Thanks, Jon. I’m just going to do as I normally do here as Jon mentioned, we just together probably just watched six months ago. So kind of quick turn on this quarter. We’ll talk about high-level financial and then walk through our balance sheet, talk a little bit about our alternative – our selling group and our product sales and finally, finish up on a little more detail on the life insurance portfolio and some cash flow before I turn it back over to Dan for Q&A. So couple of themes from the quarter, they were really – not hugely amount different than last quarter, but as compared to the first quarter 2017, some themes to keep in mind the lower policy benefit realized. So about $14.5 million versus $19 million, and that led to lower net gain $5 million versus say $8 million, demonstrates, as Jon mentioned, the business is currently configured is still overlaying upon getting more scale cash flow and earnings out of that portfolio, which we believe we’re well in our way. Second piece here for the quarter was lower purchase volumes than related unrealized gains. This is also going to feature of our call in the last probably several quarters, although our purchase volumes were bounded from sequentially from Q1 of 2017 a bit, still a little bit shorter – sorry, Q4 2017 still little bit short Q1 2017 and a lower unrealized gains. So you can see $7 million for the quarter or $94 million of buy versus $10.6 million on a $105 million, one year ago and that’s really reflecting the increased competition that we still see mainly in the broker market, which is also why we think the direct business is so important to grow. And we think that broker competition is going to remain. There’s a silver lining in that owners of these portfolio, such as itself are higher evaluation and more interest in the asset class, but putting money to work at yields we like and underwriting we like, which do not compromise our standards on those. It’s difficult and probably we’ll remain still on the broker market. Also, a little bit higher expenses Q-over-Q on an annual basis and that’s mainly due to interest on higher debt balances outstanding. Finally, we’ve got a little table here. We have some items that probably loosely called non-operating items. To give you a little better flavor for kind of how we see the underlying business running, in the column on the left, what we reported, which near the bottom was adjusted common loss attributable to common shareholders of $12.9 million or $0.22 a share. So that was the GAAP number for the quarter. When you consider if you look at the next column over we made a couple of adjustments for items that are either one-time or we don’t expect to occur either with same frequency or magnitude. If you have a few things going on, couple of which you’ll will be familiar to you if you’re on the call last time. One, we have no evaluation adjustments in our portfolio that we don’t expect to continue that was a positive, that’s a very small number relative to the overall total valuation of the portfolio, but one that does narrated in income statement, fully back that out. We had back our life expectancy evaluation. So that these are life expectancy updates again, it been featured the past several quarters, really five quarters now, where we are periodically updating life expectancies in the portfolio and these were on policies that were purchased several years ago. We’ve also indicated that we believe this to be true. That going forward we expect these to be lower for a while as we have kind of gotten through the cycle of updates for this quarter. So we had that back. And then about midway down, we had a tax valuation, which just essentially means we do not recognize tax benefits given our history of GAAP losses. So we reserve against any tax benefit that would result from our loss. And, although those numbers are not gone forever, when we established consistent GAAP profitability, we’ll be able to re-recognize a little bit. But for the current quarter, we write those off. So if you look at the business without those adjustments those are add it back, you get a little bit better perspective, it’s still $8 million or loss $1.38 a share a share, but it’s a little more probably consistent with overseeing underlying in those points above. As Jon mentioned, as you all know, we produce non-GAAP measures, which we think given other alternative view of the portfolio, and what this really does is takes the top line, which is your face amount of benefit at quarter end, and kind of compares it, it also went to the lower line, which is our non-GAAP investment cost basis that Jon mentioned as, we’re on $680 million in that range. And that represents purchase price plus capitalized interest and capitalized premiums. And for the quarter, we recognized $3 million – just over $3 million of adjusted non-GAAP net income. All right. Let’s move into balance sheet. We continue to grow our assets. We’re just under $900 million. We reported a record amount of stockholders’ equity. We have set the stage for future growth. You can see the line graph there is your leverage as measured just by total assets over total equity. So our leverage has come down to a very manageable level. And you can see back three years, kind of how we’ve grown the balance sheet, the dark portion being our assets and the lighter portion being the equity. So we are happy with that, I think we’re in a good spot. BEN transaction will do a lot transaction for that balance sheet, which is, of course, not any of these figures, but hope to have them in, when we meet again in early August. Looking at our liquidity, we have always driven to key pay high level of cash around to manage a cushion in the event that we get or continued to get lumpiness in our portfolio, which happens or we – and also to help us serve the retail debt a lot of which is short term in nature, and needs to be rolled over until in the event, it doesn’t. We carry cash around and probably not as much as we currently have here, we ended the quarter with cash and benefits receivable of which is how we define liquidity of a record amount. And, although that’s a good thing from a safety-first perspective, it remains a high priority for us to deploy that in the balance of 2018. So that we can improve our earnings on that cash. You won’t ever make a lot of money carrying that type of liquidity. And I believe that post BEN, we will have some interesting opportunities to deploy that capital. And again, as we look forward to the growth of the direct 100, which I talked to a tiny bit about, that can be an area that can take a lot of capital allocation, although I think that’s going to be a few more quarters before it begins to consume what we like to consume. But broadly, we’re happy with where we are with the balance sheet, and we think it’s a good place to be looking at our future Insurtech plans, looking at our D100 plans and looking at what the BEN transaction will do for us. Take a look at our selling group. We still enjoy strong interest from independent broker-dealer and financial adviser partners. Lots of interest in GWG and the model, the BEN transaction has also brought other people on the table that are interested in what we’re trying to create here. You see actually a slight dip in both the number of broker dealers in the number of advisers that’s not unusual, as we transitioned in January from 1L Bond offering to a follow-on offering, the previous one had expired. So this is not a typical when you get a new offering on it take some other broker-dealers, who we’re is selling the previous one to get through the due diligence and what not to sign into the new one and I expect looking forward now that we have closed of our RPS 2 successfully, you may see another drop as we look, when we report in August. And that’s not unusual at all. We still continue to enjoy strong support. As evidenced by this next slide, which is our graph of what we raised in the quarter, near record raise, split out between the RPS 2, which was officially closed out in April after $150 million offering. Still a lot of demand for high-yield non-correlated investment, although rates have risen, there really is in a fraction, when you think historically. We’re still in a very lowest interest rate environment and so attracting a lot of the interest to our products, which is great, gives us up diversified and flexible funding base as we think about the future. So we’re happy with our quarter there as we have been really ever since I been here at the firm for just about four years. Looking at our secondary life business. We – purchases have rebounded, as I described the line graph is the base amount and this is sequentially here. So we’re up $94 million in face quarter-over-quarter. The bar graph shows you the policies, the bigger portion of the bar graph have been coming from the broker market, the smaller part coming directly. So we’re still slogging it out in the broker market and trying to buy what makes sense. If there is yield to begin, you just have to look a little harder and build little picker here and you can see really our direct business has really been flat lined in here for the past several quarters and that’s why we’ve been retooling to what we think is a more sustainable piece. I can’t tell you – I can tell you our pipelines in the direct business has been growing markedly and this is really – now let’s say three to four to five weeks when we kind of completed our reorganize and how we’re approaching the business both externally as well as internal resources. So we’re happy with that. And we’ll see as we go through the balance of the year. I do expect the pipelines to continue to grow in the real question for us, is going to be more of the pull through metrics that we are experiencing, and I think that will allow us to kind of retool how we approach underwriting and engaging. So I’m pretty confident that our pipeline is going to grow dramatically. But we’ll have to see as to where we find the pull through because that’s going to really then be the formula for long-term success. So more to follow and we’ll give you an update in August. Looking at our portfolio continue to grow, we’re near that 1,000 insured lives kind of benchmark, which we believe is a kind of a tipping point and milestone that we’ve been shooting for our entire history and we’re getting really close to that, diversification is increasing, and we’re continuing to grow, and we’re seeing that as we look at our makeup of our portfolio now nearly $1.8 billion as of the end of March. We have a roughly 40% of that over aged 85. We have just over $200 million here in the far graph on the right, the bar on the, right. There are over $200 million on 90-plus and this thing is just going to continue to march to the right and until it matures which you will We like to refer this is money good and is going to take more quarters and more years for this to happen as Jon mentioned, it’s like a loaded spring and eventually, we’ll do so. It’s a great asset to have kind of underpinning all of our other growth initiatives. And so we’re eagerly anticipating the cash flows, which have been rising. So this graph here shows you the benefits, which will be the right scale versus premiums on a trailing 12-month basis, and so you can really see since, call it Q2 of 2016, we’ve been here and there about in terms of coverage and in the last six quarters, we have been comfortably on a trailing 12-month basis we’ve had benefits exceeding premiums. And so, we would expect and like to see both of these graphs as they move to the right and go up, we feel very confident with what we’ve constructed and how it fits into the balance sheet, which will be this, plus the BEN transaction when that closes with the diversification of assets and income. And then really the high-growth initiatives that our D100 and Insurtech. So we’re trying to create a really balanced portfolio of companies that can create not only high-growth opportunities, but some real stability, which will be provided by this very highly large portfolio life insurance. So happy with where that continues to be, more work to do as always on the balance sheet and on our profitability and in our strategies, which we will be look forward to update you in the next quarter. And that does it for me, I’ll turn it back to Dan if we have any questions come in, while we have been talking.

[Dan Callahan:]

Thanks, Bill. If you would like to ask a question, open your dashboard on your screen, look for the question text box and type a question in. It’s a new system for us and we are exploring ways to continue developing value for our shareholders, and we appreciate your participation and interest in the company as we had down this journey. We do have one question that’s coming.

[Dan Callahan:]

Yes, question comes from Laria [ph] at California. Are you concerned all with cost of premiums as you continue to build the portfolio and await the debt benefits?

[Bill Acheson:]

Yes. Good question. Yes, of course, that is a major – that’s our second largest expenditure, and so yes, we are concerned not from a perspective of got the wrong one or worried about the calculation. But yes, that is a major expenditure also funding requirement, which is one of the reasons we did our senior facility a few quarters ago, to create that room to fund the premiums. And so that will continue to be a big number and when you think of the portfolio performance, the premium loan is one of the key factors, and of course, one of the main things that we take into account when we price, which we won’t get into in this format, but that’s one of the ways that you buy good policies and by really understanding the premium burden relative to the life expectancy. So yes, concerned, but I think, we get the funding in place, and that’s really the key when you’re loading the spring, as Jon said, that you have the funding in place. At the end of day, job 1 is to keep these policies enforced and having the committed facility to borrow – pay for those premiums is a major step forward, which is why we took that step three quarters ago. So great question.

[Dan Callahan:]

Another question. How is your buying approach different from your competitors?

[Bill Acheson:]

That’s another great question. The main thing is that we are one of the only, if not, the only, buy and hold participant. So whatever we acquire, we are acquiring for our company. And given that we’re not fund or anything like that, management incentive is aligned with our common shareholder, which means, if we go and buy a bunch of stuff that doesn’t perform the first person in line to suffer a loss is going to be the common equity. So we buy for our own book and that introduces a level of discipline that others were buying for funds or buying for fees, broker fees or whatnot do not have. So as it relates to our portfolio approach, we typically and this may not be all that different, but since we’re not motivated just primarily by face amount, so by driving a fee or some sort of assets under management fee, we typically or chose around our average size of the policy, we try to stay smaller. And we tylically stay in the – let’s call it, four to eight year range, four to nine year range or at least we don’t go real short, though it’s too expensive, we don’t go real long with what’s required decades of premium. So I’d say the buy and hold, discipline is what – it would be the easiest number one thing that would suggest apart from our competitors.

[Dan Callahan:]

Great. One more question regarding Insurtech. Is it possible you may acquire a life insurance company at some point for yourself?

[Jon Sabes:]

Anything’s possible. We’re looking to infuse the technology into the product we fundamentally we believe that the insurance product stand to be improve to better serve the consumer, whether that’s the secondary markets or, again, we see tremendous amount of value that is being left on the table by the consumers and consequently, the insurance company gets to profit by that. We think there is a lot of opportunity in life insurance per se to improve the product. So how do we do that? Well, the best way to improve the product is to own the product. And issue the product as a life insurance company. So Insurtech is really a game changer for the industry. It will change how life insurance is underwritten priced and sold. And so how you do that and to what mechanics, whether you own a insurance company or you reinsured or you sell it through a MGA. Those are all viable ways to impact the industry. Right now, we’re focused on both how you apply Epigenetics to the underwriting machinery, we’re doing that through our scale pilot test. And we’re going to get into the marketplace and selling life insurance and allowing consumers to choose not subsidize products that can’t discern from smokers to non-smokers. So we’re going to allow consumers to begin choosing to avail themselves to the best technology to get the best price for the life insurance that they want or need and begin to work with carriers to make give them access to that data, so that they can begin to refine their thinking. Ultimately, whether or not that involves us buying a life insurance company, the future will only tell. But we’re very excited about the change that’s happening in the industry at large. And really our respect position and strategies that we have both from a secondary market and the primary of Insurtech, we think those two are very congruent and give us a unique perspective on what stance to be changed and how to change it. So we’ll continue to executing these strategies. The hard part is, they’re going to take years. It’s hard to come back every quarter, every few weeks and talk to you all and tell you how much progress we are making. I hope that is coming through. We’re making progress. We have the resources and we have some stunning strategies that we are working on right now.

[Dan Callahan:]

Thank you, Jon and thank you to everybody for participating. We will see you again in August. Have a great afternoon, and thanks for your interest in GWG Holdings.