Analyst Take: Maiden, holding on

After another dramatic week, Maiden Holdings is out of the operating theatre but still in intensive care.

The firm announced two transactions last week as it scrambled to deal with capital strain after its regulatory solvency ratio slid below 110 percent, as first revealed by this publication.

On Wednesday (29 August) the company announced that it had signed a renewal rights deal with TransRe to hand off its $800mn diversified reinsurance business, while simultaneously disclosing that it was in “advanced discussions” to sell the associated balance sheet and US-based legal entity.

The next day it reported that it had agreed to sell its US company, Maiden Reinsurance North America, to Enstar in a deal that would also see the legacy firm take on $1.3bn of liabilities.

Enstar agreed to pay $307.5mn to buy the business, versus trailing shareholder equity of $346mn – equivalent to a multiple of just under 0.9x.

The consideration and valuation multiple could ultimately change based on “certain closing adjustments” that were not disclosed.

There are numerous assets on the firm’s statutory filings that look relatively low quality – including the deferred tax assets and contingent commissions accruals – while the liabilities have a track record of being understated.

It is therefore reasonable to assume any adjustments would be to the downside – and likely to be done without much fanfare to spare the firm’s blushes.

Together, the twin deals will help to alleviate the firm’s capital issues in the short term – largely due to a reduction in required capital. The deals are also likely to ease liquidity strain, making it easier for the firm to continue to pledge collateral for its AmTrust liabilities.

Maiden has not disclosed the amount of capital relief, but sources told this publication that after closing it looks set to have a solvency ratio in excess of 120 percent – the minimum target required to avoid heightened regulatory scrutiny.

Deals buy time

The transactions have bought newly installed CEO Lawrence Metz time, but long-term issues persist. The stock market indicated its view of the deals as Maiden’s share price slid by 6.2 percent to $3.80 across the two trading days – leaving the stock languishing at 0.5x stated book value, suggesting investors do not see the corporate action as a silver bullet.

With these deals done, at this point management has relatively few other levers it can pull to create shareholder value.

One that it will look to use is aggressive expense reduction, with the company’s CFO designate Patrick Haveron indicating the firm will look for “additional operational efficiencies and expense reductions through the end of 2018”.

At year-end 2017, Maiden had 219 staff. Sources told this publication that the business is likely to look to run with as few as 20-25 employees on a go-forward basis. It is understood that fewer than 20 staff will transfer to TransRe as part of the renewal rights transaction, with the possibility that some others will transfer to Enstar.

Investment re-allocation

With Maiden exiting third-party business, the likelihood now is that the firm will drop its rating, opening the way for it to take more investment risk.

However, the more aggressive asset allocation is likely to be followed with only a relatively small proportion of its circa $4bn of assets, with the vast majority pledged to AmTrust as collateral to support the two companies’ vast quota share deal – with historically around 90 percent of investments pledged.

Sources suggested that Maiden will target an investment return a point or two higher than its historic 3 percent yield. With significant investment leverage on a small investment base, even a small uptick in yield can have a significant effect on return on equity.

However, it remains to be seen how much latitude the firm will have to execute this plan while placating AmTrust’s domestic regulators in the US.

In most states, investments in collateral trusts are required to be held in approved securities, which are typically vanilla and low-yielding unless they carry some form of guarantee from a highly rated entity. This leaves somewhat of a catch-22 situation if the firm does drop its rating.

A further issue is how AM Best would respond vis-à-vis its rating of AmTrust. The agency’s published methodology notes charges for reinsurers without a credit rating or with lower quality assets held in trusts.

The collateral Maiden posts only covers current reserves and therefore Maiden is still on the hook for further adverse development.

What’s left at Maiden?

Once the cost base is cut to the bone and the investable assets re-allocated, Maiden’s management will essentially have played its hand.

At this point the business will have transformed itself into a single-cedant reinsurer for AmTrust – taking it back to the structure it temporarily had in its very early days.

The closest comparison for the business at this stage is the partnership total return reinsurers – Watford Re, ABR Re and Harrington Re – although none of these businesses have yet braved the public markets, and some do write third-party business without using their (re)insurer partner as a front.

These businesses have been criticised by some for being over-reliant on their liability and asset managers, with their value essentially dependent upon the contracts with those parties.

Maiden will also find itself in this position, albeit with an accumulated asset base that dwarfs any of these businesses owing to its greater longevity.

As such, the long-term future of Maiden is entirely dependent on the continuation of the AmTrust quota share and the success of the cedant’s past and future underwriting.

In August, AmTrust and Maiden announced that they had deferred a decision on the future of the quota share until 31 September to allow time for the former to complete its go-private transaction with Stone Point and come to a judgement on its capital resources.

AmTrust’s management has already strongly hinted it may not require the full circa 40 percent quota share, which was equivalent to $1.95bn in 2017. And although a final decision has not been taken, it is understood that AmTrust’s management is minded to continue with a substantial quota share.

However, there are three issues that highlight the tightrope both firms still have to walk despite the recent remedial actions.

First, there is the issue of the mismatched accruals for the same items on the respective balance sheets.

AmTrust reported its reinsurance recoverable from Maiden at $4.2bn at year-end versus Maiden’s reported loss-adjustment expense liabilities of $3.5bn.

Complex accounting differences between the two mean that they may not be directly comparable, but over time – particularly as the premium volume ceded under the quota share drops – the two numbers must converge. Keeping the balances growing with new premium volumes helps kick the can down the road for now.

Second, there is the issue of the loss corridor. As previously reported, certain parts of the AmTrust-Maiden quota share deal are subject to a loss corridor based on an inception-to-date loss ratio.

This has not yet been a factor largely because newer accident years with lower loss ratios have helped offset the adverse development of older years, but this could become a factor if the deal is cancelled and recent accident years develop in line with older years.

Again, extending the reinsurance agreement helps kick the can down the road.

Third, there is a complex tax situation. Since its formation in 2007, AmTrust and Maiden’s founders have been carefully attempting to manage the two firms to avoid taxes based on clauses in the Internal Revenue Service rules called Related Party Insurance Income.

Though the details are complex, the rules are essentially designed to prevent an owner of the US insurance company stripping earnings and shifting them to an offshore entity they also control. This is why the Karfunkel-Zyskind family has always had a lower stake in Maiden than in AmTrust.

The sale of the third-party business drops all pretence that Maiden is anything but an offshore reinsurer for AmTrust. This could bring it sharply into focus for tax authorities, which may take a more qualitative view of “control” given Maiden is dependent on AmTrust for 100 percent of its premiums.

Finally, there is the intriguing possibility that any move to put the AmTrust relationship into run-off would essentially mean Maiden and AmTrust’s interest are no longer aligned.

With no go-forward relationship to maintain, the entire source of value at Maiden would be its investments and reserves. Arguably, this could call for a more adversarial approach to the AmTrust relationship. This could then in turn cause complex conflict of interest issues given the make-up of Maiden’s board.