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24 November 2017

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Investors cautious as AmTrust continues clean-up

David Bull 14 November 2017

AmTrust still has a big job on its hands to win over investors after another messy set of quarterly results that also highlighted the efforts management is making to clean up the US insurer, strengthen its balance sheet and set it on a more stable path towards 2018 and beyond.

The reaction of the markets to another earnings miss, the quick exhaustion of an adverse development cover (ADC) and a deal to spin off 51 percent of its fee business in the space of a couple of days was not promising for the company.

Click to enlarge AmTrust shares fell 11 percent last Thursday (9 November) after the results were announced and lost another 6 percent on Friday.

The shares plunged another 8 percent yesterday to close at $9.48 in New York following a note from long-time AmTrust bull Matt Carletti of JMP Securities in which he downgraded the stock to "market perform".

That means the stock has lost two thirds of its value from a year-to-date high of just below $28.00 in February this year.

After its well-documented efforts to stave off short sellers in recent years, volatility in AmTrust's stock is nothing new for the company.

But its third quarter earnings announcement was the culmination of a nine-month period that has seen the flagging carrier take significant steps to regain investors' trust.

Since strengthening reserves in its Q4 2016 results in February, AmTrust has raised capital through a $300mn share sale to members of its founding owners the Karfunkel family, disposed of its $212mn investment in National General and sold an IT platform to the insurer for $200mn.

Last week's announcement of a partial sale of its fee business is projected to raise another $950mn in gross proceeds that will further add to its capital base.

And after replacing its previous auditor, BDO, with KPMG in April 2016, the insurer has also set about tightening financial controls and addressing concerns about its accounting.

In the wake of restating 2016 results earlier this year, AmTrust has added resources to its senior financial leadership, and most recently replaced CFO Ron Pipoly with Adam Karkowsky.

Click to enlarge In the statements announcing the various actions taken this year, AmTrust chairman and CEO Barry Zyskind has talked about simplifying and strengthening the company's balance sheet, reducing volatility and creating more confidence and certainty in its future financial performance.

He has also highlighted the value he says the insurer has been able to unlock from its technological investments with the sale of a policy management system to National General, and the part-sale of a portion of its fee business to private equity firm Madison Dearborn.

The fee business transaction in particular confounded the expectations of some banking sources who had expressed scepticism over AmTrust's ability to execute a sale while retaining a significant investment that could see it benefit from the upside of future growth.

The deal also allows AmTrust to continue using the unit as a distribution arm for its own underwriting going forward.

On the insurer's earnings call, Zyskind noted that the transaction would create around the same amount of tangible book value growth as had been created in the first 11 years of AmTrust being a public company, while retaining a sizable fee business with more implied value than reflected on the balance sheet.

The deal and related reduction in goodwill and intangibles is forecast to add around $3.50 to book value per share and $6 to tangible book value per share.

He added that new capital generated by the sale and other transactions this year would allow AmTrust to support new writing, as well as rethink its debt profile and "explore changes to certain key reinsurance structures".

That could include taking back some of the premium that is currently ceded away.

Click to enlarge Based on current levels of net written premium of $3.89bn for the first nine months of 2017, AmTrust's underwriting leverage to tangible book value of $2.37bn is around 1.65x.

That already represents a significant reduction over the last couple of years from 1.82x at the end of the third quarter in 2015 and 2.42x a year earlier.

All else being equal, the impact of proceeds generated by the sale to Madison Dearborn would send that ratio significantly lower again.

Despite what looks to be a bolstered balance sheet going into 2018, the concerns of investors and ratings agencies are likely to remain focused on the adequacy of AmTrust's reserves, however.

At the time it agreed the ADC with Premia Re, Zyskind said: "We are providing confidence to all our stakeholders that we are well insulated from any potential reserve volatility in the future."

The speed which AmTrust has gone through the cover will have left some observers worried, however.

Karkowsky said the insurer believed it had increased certainty around reserves on the 2016 and prior accident years by using the full benefit of the ADC.

"We believe we have established a reserve base that mitigates uncertainty on previous accident years and we are exercising more caution on the 2017 accident year to insulate the company from future reserve volatility," he said.

"Even after recognising the prior-year development, primarily in accident years 2013 through 2016, our overall underwriting business was profitable."

Excluding the benefit of ceding losses to the ADC, AmTrust has a year-to-date loss ratio of 66.8 percent and a combined ratio of 95.0 percent.

The only segment with a combined ratio above 100 percent is specialty program, at 104.0 percent in the year-to-date, following a 106.6 percent average combined ratio for the years 2012 through 2016.

But in a note explaining its decision to put AmTrust under review with negative implications last week, AM Best said the latest actions "raise questions about the potential future movement of reserves for these accident years... and about price adequacy and underwriting practices for the current and more recent accident years".

The under-review status also reflected the uncertainty regarding future changes in loss reserves and current year pricing and underwriting actions, it added.

"The negative implications assigned to the under-review status reflect AM Best's expectation that reported financial results for 2017 will deteriorate from prior years' results and from expectations, and result in an associated deterioration in risk-adjusted capital at the AmTrust holding company," the ratings agency said.

With a reduced number of equity analysts now following the stock, notes responding to Q4 earnings and last week's actions have been scarce.

Compass Point's Ken Billingsley, who maintained a "buy" rating on AmTrust but lowered his price target from $20.00 to $15.00, said he believed the insurer was "trying to clean house" before the start of 2018.

But Carletti downgraded AmTrust to "market perform" because the "near-term risk/reward profile for the stock has changed".

Despite the fee business sale and "correct" steps being taken for the long-term health of the business, Carletti pointed to increased potential for negative catalysts in the intermediate term, including the prospect of an AM Best downgrade.

Carletti was also surprised at the ADC exhaustion, and said the insurer would have to regain the trust of investors in its reserves.

Those concerns are reflected in the 0.8x book value multiple shares are trading at, he said.

"Longer-term, if management were to show several quarters without adverse development, timely file the company's 10K with successful remediation of material weaknesses, and if AM Best removes its negative outlook, we believe the shares could recover toward tangible book value once the fee business sale is completed," he suggested.

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This article was published as part of issue November 2017/2

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