Greenlight Capital Q3 2008 Earnings Call Transcript

| About: Greenlight Capital (GLRE)

Greenlight Capital (NASDAQ:GLRE)

Q3 2008 Earnings Call

November 5, 2008 9 a.m. ET


David Einhorn – Chairman of the Board

Leonard Goldberg – Chief Executive Officer, Director

Barton Hedges – President and Chief Underwriting Officer

Tim Courtis – Chief Financial Officer


Jim Bradshaw – Bares Capital Management

Marvin Kline – Logan Capital

[Ian Macover] – BlackHawk Capital

Andrew Sole – Esopus Creek Advisors

Mark Salem – Mount Capital



Good morning everyone and welcome to the Greenlight Capital Re third quarter 2008 conference call. Joining us on the call this morning is David Einhorn, Chairman; Len Goldberg, Chief Executive Officer; Barton Hedges, President and Chief Underwriting Officer; and Tim Courtis, Chief Financial Officer.

The company reminds you that forward-looking statements that may be made in this call are intended to be covered by the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, but rather reflect the company’s current expectations, estimates, and predictions about future results and events that are subject to risks, uncertainties, and assumptions including risks, uncertainties, and assumptions that are enumerated in the company’s annual report on form 10-K for the fiscal year ended December 31, 2007 and other documents filed by the company with the SEC.

If one or more risks or uncertainties materialize or if the company’s underlying assumptions prove to be incorrect, actual results may vary materially from what the company projects. The company undertakes no obligation to update publicly or revise any forward-looking statements or the added result of new information, future events, or otherwise. Today’s call is being recorded. (Operator Instructions)

I would now like to turn the call over to Mr. Leonard Goldberg.

Leonard Goldberg

Thank you very much and good morning. My name is Leon Goldberg, Chief Executive Officer of Greenlight Re. Thank you for taking the time to join us this morning. The third quarter of 2008 was a good quarter for our underwriting portfolio and a difficult quarter for our investment portfolio.

Our net loss for the quarter was $118.4 million or $3.29 per share. Our fully diluted book value per share was $14.22 as of September 30, 2008, a 9.9% decrease from $15.78 per share as of September 30, 2007. In addition, we had an October investment loss of 12.7% or approximately $79 million. While we are not pleased with our performance, we believe we have proven our ability to navigate through some of the most difficult obstacles we could ever imagine and remain in a strong position to capitalize on new opportunities.

We believe that our premium to capital ratio is among the most conservative in the industry. This should serve us well in the near term, as we expect reinsurance pricing to improve, in some cases dramatically so. We intend to continue to pursue our strategy of maximizing risk adjusted returns on both sides of the balance sheet.

Gross written premium increased for both the third quarter and the year-to-date, compared to the corresponding periods in 2007. In the second quarter, we told you that premiums were coming in lower than initially expected, as our clients were protecting their interests and ours in a softening market. Even at these lower than initially expected levels, our premiums have increases year-over-year, as we continue to expand and diversify our portfolio.

As of September 30, 2008, frequency business makes up 79% of our premium volume compared to 59% as of September 30, 2007. These statistics reflect the implementation of our focus on expanding our frequency business. This focus served us well in the third quarter, as we did not suffer an insurance loss from Hurricanes Ike or Gustav.

Our President and Chief Underwriting Officer, Barton Hedges, will talk in greater detail about our underwriting portfolio in a few minutes. Now, I would like to introduce our Chairman, David Einhorn, who will discuss our overall progress and recent investment results. David.

David Einhorn

Thanks Lenny. We appreciate everyone taking the time to join us for the call this morning. As you know, Greenlight Re’s investment portfolio is managed by DME Advisors LP, an affiliate of Greenlight Capital. Greenlight Re’s third quarter investment portfolio results of -15.9% was the worst quarterly performance result in Greenlight Re’s history. We are extremely disappointed with this result.

We have been cautious about the environment since last July. A more conservative net long portfolio exposure compared to our historical positioning helped us weather the financial crisis in the last half of 2007 and the first half of 2008. By adding additional short exposure, particularly in the financial sector, which was most directly responsible for the credit crisis, we believed that we positioned the portfolio to preserve capital, should the financial markets deteriorate further. We were wrong.

Through the third quarter, Greenlight Re’s portfolio was approximately 17% net long. This is the lowest net long quarterly waiting we’ve maintained. We made the mistake of thinking that our significant short portfolio would protect a fairly fully invested long portfolio, that we estimated to be attractive and cheap. In hindsight, we should have been more conservatively positioned from a gross invested standpoint and we took measures to bring down overall exposures in September, as global financial markets deteriorated further.

In September, the US Government took an unprecedented action by banning the short selling of approximately a thousand financial firms, in order to prevent the systemic collapse of the financial system. The stocks that Greenlight Re was short withstood the center of the problem from financial industry are the same stocks that investors believed to be direct beneficiaries of government actions.

While the short selling ban failed to prevent a decline in the overall market, it did support the short term share prices to certain companies. During the quarter, our long portfolio underperformed the S&P, which declined about 9%, while our short portfolio only made a minimal gain. Our long portfolio suffered from analytical errors and a couple of names, and from the wide spread deleveraging occurring across the globe. Greenlight Re generally does not employ leverage in its investment portfolio because we want to be able to withstand systemic shock and not be put into a position to be forced to sell longs or (inaudible 00:06:23) shorts that we believe to be long term attractive investments because of temporary dislocations.

We entered our October with a small positive net exposure. Despite this positioning, our investment portfolio sustained a further loss of 12.7% during the month of October. The biggest contributor to the loss was our long position in Helix Energy Solutions, an energy company that was hurt by both declining oil prices and the recent hurricanes in the Gulf of Mexico.

The second biggest loss came from a relatively small position we held in the Porsche Stock, whereby we were long Porsche stock and short in Porsche’s ownership in Volkswagon stock. As has been widely reported, both Heiman shares appreciated over 350% in two days after Porsche announced that it cornered the market in Volkswagon shares and invited short sellers to “close their positions unhurriedly and without bigger risks.” Even though this was not a large position, a move of this magnitude did create an outside loss.

I’d like to talk a bit about how Greenlight Re’s portfolio is positioned today and where we stand going forward. Our portfolio is more net long than at the beginning of October. As Greenlight Re has been a net buyer in the global equity market’s collapse in the first half of October, while our short exposure decreased at the same time. We remain long cash-flow positive companies with generally unlevered balance sheets that we believe have already priced at a severe downturn.

We continue to be short companies that we believe will be challenged given the real and present headwinds our economy faces today. Mainly we continue to be short large financial institutions with levered balance sheets, thought to be the best of brief companies that are being severely impacted by the contraction of credit. We are also short companies with optimistic assumptions that are exposed to a weakened consumer. There are plenty of opportunities to evaluate and we think that there will be an expanded opportunity set in the future, although we currently remain in a conservative posture and plan to be patiently opportunistic.

The most important ongoing concern at Greenlight Re is preservation of capital in generating positive risk adjusted returns. Although our investment portfolio hasn’t accomplished this goal recently, we believe our investment approach and discipline will allow us to generate positive risk adjusted returns to our shareholders in the long term.

On the underwriting side, we are excited about the current changes in the market. We believe that the price of risk has increased everywhere, including in the reinsurance industry. Greenlight Re was built specifically to the opportunistically right business and markets where demand for reinsurance greatly exceeds supply. We believe that given our conservative underwriting approach to date, we have the capacity and the expertise to take advantage of any dislocations arising in the market.

Now, I’d like to turn the call over to Bart to discuss Greenlight Re’s underwriting portfolio, in particular, a look forward into 2009.

Barton Hedges

Thanks, David. The third quarter 2008 was a continuation of the same underwriting strategy that we have employed since we began underwriting business in early 2006. We continue to find excellent partners in a number of lines of business, which has allowed us to diversify our portfolio. As Lenny previously mentioned, we have been building out the frequency portfolio, which is now significantly larger than the severity portfolio. While we have no targets and the mix of business will fluctuate from time to time, we believe our portfolio will always maintain a frequency orientation.

There were two major hurricanes that made landfall in 2008, Gustav and Ike. There were also a number of smaller CAT events. We have taken no losses from these events. The major reason for this was a well-defined strategy in 2007 and 2008 to deploy our catastrophe capacity at higher layers mixed with a bit of luck.

We took this high access approach for two reasons: First, we thought the pricing was better. And second, if we did take a loss, we wanted the event or events to be large enough to move pricing prospectively, so that we could be in a position to redeploy capital the following year at those higher rates. Even though Ike loss estimates continue to up, we believe our covers are far enough away from the action, that even significant increases to current estimates would not present an issue for us.

As Lenny and David mentioned, September and October were volatile months for our investment program. However, we believe our premium to capital ratios are still amongst the lowest in the reinsurance industry. Since we focus on frequency business, we believe our underwriting program should also be less volatile over time than CAT focused reinsurers. We believe that our third quarter underwriting results have proven this point.

We do not believe current events will have a significant impact on our underwriting strategy. Most of our existing clients are small, specialty companies, single state writers, risk retention groups, specialists, (inaudible 00:11:17) syndicates, captives, and the like. We believe most of our current client base trades with us because of our value added approach to the issues and our A- A & Best rating.

We also believe that there is a large potential client base of these specialist organizations that we will be able to selectively add to the portfolio over time. We believe that it is very much business as usual for the underwriting portfolio, except for one thing, as David mentioned, the price of risk has increased across the spectrum and reinsurance is no exception.

For 2009, we are already seeing signs of a hardening natural catastrophe market. If these trends continue, 2009 could be a year in which we may opportunistically expand our natural catastrophe portfolio. However, since our orientation is for frequency business, we will seek to limit our exposure in this area. If natural catastrophe capacity is scarce, we will also judiciously utilize this capacity to deepen our relationships with clients in other lines of business.

The casualty picture is much less clear at the moment. We believe pricing will increase, but not necessarily immediately. In fact, the original pricing in some of this business could go down in the short term, as the healthier insurers compete for market share at the expense of the less healthy companies. So, we will tread carefully.

We believe that the credit crisis and the subsequent economic downturn will create liability issues in a number of lines of business, most noticeably, directors and officers, or D&O coverage. We have a limited amount of D&O exposure through some of the clash contracts that we wrote and discussed in earlier calls. We have recognized losses on some of these clash contracts, but we have yet to see the industry as a whole recognize the D&O issues that will emerge both on a primary and reinsurance basis. We believe that once major players start recognizing these losses, the effect on pricing in both D&O and other casualty lines could be dramatic.

Overall, we believe our current portfolio will benefit from a hardy market and an increased cost of risk. We expect that we’ll be in a good position to add new, long term frequency clients, as well as write both property and casualty severity contracts on an opportunistic basis. If the markets harden as expected, our strategy of preserving capital in softer markets, and deploying more capital in harder markets, will begin to play out more clearly in 2009.

And now, I’d like to hand it over to Tim Courtis, our Chief financial Officer, to discuss our third quarter financial results.

Tim Courtis

Thank you, Bart. Greenlight Re reported a net loss of $118.4 million for the third quarter of 2008, compared to a net loss of $2.1 million for the comparable period in 2007. On a per share basis, the loss for the three months ended September 30, 2008, was $3.29 per share, compared to a loss of $0.06 per share for the third quarter of 2007.

For the nine month period ended September 30, 2008, the net loss was $89.6 million compared to net income of $6.1 million for the nine months ended September 30, 2007. On a per share basis, the net loss was $2.49 per share, compared to net earnings of $0.21 per share on a fully diluted basis for the comparable period in 2007.

Premium written during the third quarter of $37.7 million was higher than the 19.8 million of premium written during the third quarter of 2007. This increase is primarily the manifestation of the additional quota share frequency business that we have written during the latter part of 2007 and continuing into 2008. As mentioned in previous quarters, it takes longer for the ultimate premium on the quarter share contracts to be reported.

The composite ratio for our frequency business for the first nine months of 2008 was 88.9%. This compares to the reported composite ratio of 93.7 % for our frequency business for the comparable period in 2007. The improved composite ratio on the frequency business is primarily a result of favorable loss development on certain 2006 and 2007 frequency contracts. The composite ratio for our severity business for the first nine months of 2008 increased to 73.1 % compared to 39.9% for the comparable period in 2007.

The increased composite ratio on our severity business is a combination of writing a more diverse line of business mix during 2008, which have inherently higher loss ratios, as well as increased loss estimates on certain 2007 severity clash contracts.

The aggregate composite ratio of 83.7% reported for the first nine months of 2008, for both frequency and severity business, compares to an overall composite ratio of 81.2% reported during the same period in 2007.

Internal expenses for the nine months ended September 30, 2008 were 13.8% of net premiums earned, resulting in a combined ratio of 97.5% for the first nine months of 2008. As previously mentioned, for the third quarter we reported a net investment loss of $117.8 million, reflecting a net loss of 15.9% on our investment account. For the nine months ended September 30, 2008, we reported a net investment loss of $92.5 million or a net loss of 12.9% on our investment portfolio for the year-to-date.

In closing, we want to once again stress our belief that long term growth and fully diluted book value per share is our most important metric. When we look at the 12 months ended September 30, 2008, fully diluted book value per share decreased to $14.22 from $15.78 at September 30, 2007. This represents a decrease of 9.9%. I’ll now turn the call back to Lenny, who will provide some concluding remarks.

Leonard Goldberg

Thanks, Tim. While the third quarter of 2008 was difficult across all financial markets, we believe that we have weathered the storm and are positioned to take advantage of an increasingly hardening market in 2009 and beyond. We will continue our strategy of maximizing risk adjusted returns on both sides of our balance sheet and will continue to proceed cautiously.

Finally, as part of our ongoing ratings process, we continue to maintain close communication with A & Best. As is our normal practice, we have kept A & Best fully informed of all developments on both our underwriting and investment portfolios up through the present. A & Best has confirmed to us that the events through the end of October will not create any issues related to our rating and that we are currently more than adequately capitalized, even under significant stress testing of our capital base. And now, we’d like to open the call up to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Jim Bradshaw, of Bares Capital Management.

Jim Bradshaw – Bares Capital Management

Good morning. I wonder if you could just speak briefly about your credit facility with Citi and whether or not you are seeing any tightening of that at all?

Tim Courtis

Hi, it’s Tim Courtis, we do have a $400 million letter of credit facility with Citi Bank. It is annually renewable and currently runs to the fall of 2009. We have not had any discussions with them otherwise.

Jim Bradshaw – Bares Capital Management

Okay. Great. I think you guys already answered most of my other questions, so, appreciate it!

Tim Courtis

Thanks, Jim


(Operator instructions) At this time, there are no further questions. We now have a question from a line of Marvin Kline, of Logan Capital.

Marvin Kline – Logan Capital

My question has to do with the recent price of the stock. Do you have any reason to suspect that there’s been a lot of dumping of the stock by hedge funds who are trying to improve their liquidity?

Tim Courtis

Hey, Marvin. We really have no insight into whether that’s the case or not.

Marvin Kline – Logan Capital

Okay. Thank you.


Your next question comes from the line of Ian Macover (ph 00:20:20), of BlackHawk Capital

[Ian Macover] – BlackHawk Capital

Hi, good morning. David, I was wondering if you comment on the extent to which currency movements may have contributed to investment losses in recent quarter?

David Einhorn

Um, I don’t have that in front of me, but my instinct is that currency movements, believe it or not, were actually probably a positive.

[Ian Macover] – BlackHawk Capital

I know they were a positive in October.

David Einhorn

Thank you, but that was not a question.

[Ian Macover] – BlackHawk Capital



(Operator Instructions) Your next question comes from the line of Andrew Sole of Esopus Creek Advisors.

Andrew Sole – Esopus Creek Advisors

Good morning and I apologize if this question- if you’ve already addressed this issue, I got on the call a little late. Can you tell me if the company still has exposure to this Porsche VW trade.

David Einhorn

Yes, I can address the question. Um, we do not have a practice of disclosing exactly what our current positions are or our current trading strategies relating to particular names. So, it’s something we’re probably not going to answer at this time.


Your next question comes from the line of Mark Salem of Mount Capital.

Mark Salem – Mount Capital

My question for David, I guess in relation to the previous question, but with what we’ve seen in Porsche/VW, at any time did you have any issues regarding, you know, margin calls or um, you know, uh any kind of prime brokerage issues with that position?

David Einhorn

We did not have any prime brokerage issues with that position and we did not have specific margin calls. We rerun the fund on the account on an online bird basis. And as such, we have significant ability not to have to worry about haircuts and things such as this.

Mark Salem – Mount Capital

Just a followup, could you give an idea of just, you know you mentioned this two positions that contributed to the loss, can you give us a rough idea of how much they contributed to October’s performance?

David Einhorn

Helix was the bigger of the two. And the two of them combined were much of the loss.

Mark Salem – Mount Capital

Thank you.


(Operator Instructions) There are no further questions. Should you have any followup questions, please direct them to Alex Stanton of Stanton, Crenshaw Communications at 212-780-1900 and he will be happy to assist you. This concludes today’s conference call.

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