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Greenlight Capital Re, Ltd. (NASDAQ:GLRE)

Q4 2009 Earnings Call Transcript

February 25, 2010 9:00 am ET

Executives

Len Goldberg – CEO

David Einhorn – Chairman

Bart Hedges – President and Chief Underwriting Officer

Tim Courtis – CFO

Analysts

Jim Bradshaw – Bares Capital Management

Eileen Gannon [ph] – Balfour Management

Alec Ofsevit – Credit Suisse

Ron Bobman – Capital Returns

Bernie Lanigan – Southeast Asset Advisors

Operator

Thank you for joining the Greenlight Re conference call on fourth quarter and full year 2009 earnings. Joining us on the call this morning is David Einhorn, Chairman; Len Goldberg, Chief Executive Officer; Bart 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 and are subject to risks, uncertainties and assumptions, including risks, uncertainties and assumptions that are enumerated in the company's Form 10-K dated February 24, 2010 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, whether as a result of new information, future events or otherwise. Please note today's presentation is being recorded.

At this time, I would like to turn the conference over to Len Goldberg, Chief Executive Officer. Please go ahead, sir.

Len Goldberg

Thank you and good morning. My name is Len Goldberg, Chief Executive Officer of Greenlight Re. Thank you for taking the time to join us today.

The fourth quarter of 2009 puts a cap on what was an excellent year for Greenlight Re. Throughout 2009, we received strong contributions from both our underwriting and investment portfolios. Fully diluted adjusted book value per share increased 8.8% for the quarter and over 40% for the full year.

We continue to build float and underwrite at less than 100% combined ratio while accepting much less catastrophe risk exposure than our competitors. And we are pleased to have achieved this performance with a low leverage business model featuring no corporate debt, a low premium to capital ratio and a defensively positioned investment portfolio.

Our underwriting portfolio continued to perform well. Our combined ratio for the full year 2009 was 96.5%, the same as in 2008. Our premium growth has primarily come from the organic growth of existing relationships. We suspect this will continue through 2010 as pricing in the insurance and reinsurance markets is generally not acceptable. We have, however, opportunistically entered some new business lines, which Bart will discuss later.

Our gross written premium increased 78% in the fourth quarter of 2009 versus the same period a year ago and is up 59% for the full year versus the comparable period in 2008. Our net earned premium increased 83% in the fourth quarter of 2009 compared to the same period in 2008 and is up 87% for the full year 2009 over the prior year.

The hard market we had been expecting early in 2009 lasted about six weeks. Once the financial markets rebounded in early March, price competition returned in earnest. Though most areas remained soft, we continue to see meaningful price increases in employer stop loss business.

Catastrophe retrocessional business also continues to hold up well. We have not seen positive price movements across the rest of the portfolio. Our emphasis continues to be on more stable frequency oriented business. In 2009, frequency business comprised 88% of the gross premium in our total portfolio, up from 83% in 2008 and 61% in 2007. As mentioned last quarter, we believe that our portfolio should hold up well, even if property and casualty pricing continues to deteriorate, as we are confident that our business partners will act responsibly and protect our capital.

On the investment side, we continued our strong 2009 performance with a 6.4% return for the fourth quarter of 2009 and a 32.1% return in our investment account for the full year. It is worth mentioning that we outperformed the S&P 500 for the fifth time in five years with a defensively positioned portfolio that would have greatly reduced our downside should the markets not have rebounded since last March. In January of 2010, our portfolio gained 0.4%.

Our investment strategy is unique amongst reinsurers for a number of reasons but primarily we have benefited from the ability to quickly reposition the portfolio as the environment has changed. While it has been a challenging investment climate between late 2007 and today, we have been able to avoid some of the worst of it and take advantage of some good opportunities.

And now, I'd like to turn the call over to our Chairman, David Einhorn, to discuss our investment results in more detail and the progress in Greenlight Re's overall strategy.

David Einhorn

Thanks, Len, and thanks, everyone for joining us today. Our investment portfolio performed well in the wake of the financial crisis as many of the mispriced securities and debt instruments we owned and purchased during the crisis appreciated.

The 2009 return was generated with the most conservative net investment exposure we've maintained in any calendar year to date about 29% net long including an average of 17% in debt instruments. Just as our short portfolio helped mitigate the loss in 2008, the 2009 return came mostly from our longs dramatically outperforming our shorts. However, the gain in the short portfolio in January, February and October of 2009 drove our combined positive performance of 3% in those months where the S&P declined a combined 21%.

Also, when viewed over a two year horizon, that includes the historic market collapse followed by last year's sharp recovery beginning in March, we feel we did a decent job of preserving capital and being opportunistic, which had the combined effect of producing a positive 8.9% return over the combined two year period. Coupled with an underwriting team that has been profitable and additive to book value, we're pleased at how the two sides of our balance sheet have fared through a historically challenging environment.

During the fourth quarter, our positive return was generated by a combination of good performance from several loans including CIP Group Debt, which appreciated 30% as it completed its bankruptcy reorganization and our position in physical gold.

Physical gold prices advanced approximately 9% during the quarter as fiscal and monetary stimulus continued at crisis levels even though the peak of the crisis passed more than a year ago. The investment portfolio entered 2010 about 20% net long including about 11% in debt. We've been transitioning out of a few successful debt investments where there is limited potential for further appreciation into some new long equity positions.

Our long portfolio is, for the most part, invested in stable, less cyclical businesses, and we continue to be short businesses that should be fundamentally challenged, especially in a difficult economic environment. Given the challenging macro economic environment, we continue to hold a significant position in gold and have other macro hedges in place in the form of options on higher interest rates and some corporate and sovereign CDS.

The portfolio continues to be conservatively positioned in 2010 because the market appears to be discounting a strong economic recovery and many of the valuation to the market implies deep recovery through at least 2012. The S&P 500's currently trading about 23 times what may or may not turn out to be trough earnings as we believe the stimulus benefits have peaked and the inventory recovery is peaking.

With unemployment at around 10%, household debt to income by 120% and our leaders clearly putting the long-term viability of our currency and fiscal position in jeopardy to attempt to avoid further short term pain, we'll continue to exercise caution during these uncertain times. Greenlight Re had a solid year on the underwriting side.

We continue to develop our book of business without any missteps. In what turned out to be a disappointing year from an industry pricing perspective, we've grown the team with several senior hires that have already meaningfully contributed to our success and we believe we are well positioned for a strong 2010. So now, I'd like to turn the call over to Bart to discuss in more detail the underwriting progress.

Bart Hedges

Thanks, David. In 2009, we were able to expand our underwriting revenue while maintaining our profitability. This was a great accomplishment, given the general downward pressure on pricing throughout the year.

We believe we were able to accomplish this by staying true to the underwriting philosophy we have discussed from the inception of Greenlight Re. We were able to grow our premium through a concentrated portfolio comprised of specialist clients that we know well.

Even though we grew our premium by almost 60%, our contract count actually was flat between 2008 and 2009, aided by the organic growth of our clients and the strategic investments that we have discussed in prior quarters. Finally, we have concentrated our portfolio in a small number of businesses rather than writing across the entire marketplace.

While we have been active in a number of lines such as motor vehicles and medical malpractice, our main successes have been in employer stop loss, property cat retro, small commercial accounts and Florida home owners. We began underwriting employer stop-loss business in late 2007 when it became clear to us that the pricing cycle for this business was not synchronized with the overall property and casualty pricing cycle.

We grew this business through a small number of partners in 2008 and 2009 and expect continued growth in 2010. Pricing has been strong for the last two years with price increases in excess of loss trends. Consistent with our business strategy, we will continue to pursue these opportunities until we believe the trends are going the other way.

In addition, this is frequency oriented business that we like with a very short tail and relatively low volatility. Another success has been property cat retro. We are entering our fifth year in this business and while catastrophe reinsurance pricing has been deteriorating, cat retro pricing has been holding steady at a level similar to the post-Katrina rates of 2006.

We believe the main reason for this is that most of our competitors prefer to write property catastrophe so they can achieve spread of risk. Once they write a significant reinsurance book, it is difficult to also write cat retro business.

We prefer to get the best return per dollar of risk and we are happy with the small cat retro book that covers peak exposures. It is not a big portfolio, generally around 5% of our total premium writings, but the risk return profile is excellent and the results to date have been good.

We generally position this book so that it would take a very large individual loss or a series of large losses to hurt us. For example, Ike and Gustav did not affect us in 2008 and we expect that a similar loss in 2010 would not impact us greatly. Our maximum catastrophe exposure to any one event decreased to $58.5 million in the fourth quarter of 2008 from $64.2 million in the third quarter, while our aggregate maximum exposure to all catastrophic events has come down slightly to $97.5 million in the fourth quarter of 2009 from $99.4 million in the third quarter.

In other words, our cat portfolio's basically flat. As a reminder, we always state our catastrophe aggregates as the absolute amount of limit we have at risk less any reinstatement premiums. We have made good progress with small commercial accounts. These are generally small premium frequency oriented accounts that we reinsure through a small number of relationships with regional or other specialist companies.

The dominant lines are workers comp and general liability. While we have always liked this business, it has been more advantageous to us in the recent soft cycle as small account pricing has not come under the same kind of pressure as large accounts. We also believe our partners in this area achieved loss ratios that are superior to the overall market.

We expect small commercial accounts to continue to be a growth opportunity in 2010. Finally, we have selectively written Florida homeowners business on an ex-win basis since late 2006 and that has performed well for us. Currently, the market is in somewhat of a crisis as the number of smaller homeowners insurance companies have stopped writing due to capital concerns. These events have caused the state of Florida to approve price increases in homeowners' rates.

This will make the business more profitable and increase top line premium and in turn, will require more companies to look for capital support in the form of Florida share reinsurance. Since we have been active in this market for a number of years, we believe we will see our share of any new opportunities. The only new business we have entered thus far in 2010 is trade credit and surety.

While the overall property casualty market pricing is still heading the wrong way, there have been some good opportunities in some of the credit and surety lines that have been hit by recent losses caused by world economic downturn. Some capacity has left the market and we believe there will be an opportunity here for us for the next few years.

As is our custom, we are working with business partners who we believe are experts and have many years of experience in this business. While this will not be a particularly large concentration for us in the current environment, we believe the risk return characteristics in the near-term make them a good addition to our reinsurance portfolio.

While we expect overall premiums to increase in 2010 from the business we have already bound, we still believe we have significant untapped underwriting capacity that we are reserving for a time when the pricing churns eventually comes.

But, for now, as Lenny stated, we believe we have a well positioned underwriting portfolio should prices drop from here and are poised for growth should pricing begin to increase towards the end of 2010 or into 2011.

And now, I'd like to hand the call over to Tim to discuss our financial results.

Tim Courtis

Thanks, Bart. Greenlight Re reported net income of $57.3 million for the fourth quarter, compared to a net loss of $31.3 million for the comparable period in 2008. On a fully diluted per share basis, the net income was $1.65 per share for the three months ended December 31, 2009, compared to a net loss of $0.87 per share for the same period in 2008.

For the full year ended December 31, 2009, net income was $209.5 million, compared to a net loss of $120.9 million for the year ended December 31, 2008. On a fully diluted per share basis, net income was $5.71 per share, compared to a loss of $3.36 for the comparable period in 2008.

Net premium written and earned are substantially higher than comparable periods in 2008. Net earned premiums for the year ended December 31, 2009 were $214.7 million, an increase of 87% when compared to the net earned premium of $114.9 million reported in 2008.

We reported net investment income of $51.2 million for the fourth quarter of 2009, reflecting a net return of 6.4% on our investment account. We reported net investment income of $199.9 million for the 2009 calendar year reflecting a net investment return of 32.1%.

The composite ratio for our frequency business for the year ended December 31, 2009 was 95.2% and it was 59.5% for the severity business, resulting in an overall composite ratio of 87.7%.

Internal expenses were 8.8% of net premiums earned for the 2009 fiscal year, as compared to 12% reported for 2008. The total amount of operating expenses for 2009 grew by $5 million to approximately $19 million as we have expanded our underwriting capabilities. However, the internal expense ratio has decreased as a result of the substantial growth in premiums produced from our frequency dominated underwriting portfolio.

Greenlight Re's combined ratio for the full year 2009 was 96.5%, the same as the combined ratio for 2008. As I advised in our first quarter 2009 earnings call, commencing in 2009, U.S. GAAP mandated that non-controlling or minority interest be shown on the balance sheet as a component of shareholders' equity. The change affected the reported book value per share.

We believe that removing such non-controlling interest from the calculation of book value per share provides more meaningful information and we will start reporting adjusted book value per share excluding this non-controlling interest.

As such, the fully diluted adjusted book value per share as of December 31, 2009 was $18.95, a 41.5% increase from $13.39 per share as adjust -- as reported at December 31, 2008.

I now would like to turn the call back to Lenny who will provide some concluding remarks.

Len Goldberg

Thanks, Tim. We created the Greenlight Re strategy to enable our company to achieve sustainable advantage in a wide variety of markets. The fourth quarter and full year 2009 results are great examples of the power of our business strategy.

In addition, the strong results of 2009 have added significantly to our capital base, adding to our dry powder and giving us increased flexibility in what are still somewhat stressed and uncertain financial market.

We have executed this differentiated strategy consistently since we started operations in 2005. Our objective is to write a concentrated underwriting portfolio with the best risk adjusted returns we can find and to utilize the float generated from these contracts to invest in our deep value long short investment program, which has generated superior returns with less volatility than the overall equity market.

We will continue to execute on this strategy and remain focused on driving increased book value per share. We appreciate your continued confidence in Greenlight Re.

Thank you again for your time. And now, we'd like to open the call up to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jim Bradshaw of Bares Capital Management.

Jim Bradshaw – Bares Capital Management

Thank you. Good morning, guys. I wonder if you could give an update on how the opportunities are looking for the Verdant subsidiary.

Len Goldberg

Hi, Jim. This is Lenny. How are you?

Jim Bradshaw – Bares Capital Management

Great. Thanks.

Len Goldberg

Right now, as we discussed in our K, we're sort of using Verdant to make a small number of strategic investments and that's pretty much all that we're doing with Verdant right now.

Jim Bradshaw – Bares Capital Management

Okay. So, nothing really new. All right. Thanks. I think you guys answered most of my other questions already. So appreciate it.

Operator

Our next question is from Eileen Gannon [ph] of Balfour Management.

Eileen Gannon – Balfour Management

Hi, guys. Given the new writings in surety and credit, how did you get comfortable modeling out the correlated credit risk? And given Greenlight's capital expertise in historically identifying and analyzing that risk, was this joint effort between the underwriting and the investment team?

Len Goldberg

This is Lenny. I'll take that question. The trade credit market has been around for a number of years and we were able to look at a significant amount of historical information, including some of the things that happened in late 2007, 2008 and 2009. And it gave us the ability to look at the tail risk and get comfortable with that risk.

We did not use our friends at Greenlight Capital extensively in that analysis but we have shared that analysis with them.

Eileen Gannon – Balfour Management

So, in the event that we end up back in the environment that was outside of the model forecast, give us a sense of the maximum exposure here?

Len Goldberg

We think that the maximum exposure should be pretty well contained by the structure of the credit insurance market itself. We don't have a total premium number right now, so we don't have a real -- one single number I can give you for the downside we're very confident that this sort of risk is well contained and controlled.

Eileen Gannon – Balfour Management

Thank you.

Operator

Our next question is from Alec Ofsevit of Credit Suisse.

Alec Ofsevit – Credit Suisse

Good morning, guys. My first question on the underwriting side is can you describe a little bit about how you manage the correlation of just any individual contract that you're looking at writing within relation to your overall book?

Len Goldberg

Sure. We tend to do that on a contract-by-contract basis because we write a fairly concentrated portfolio. And generally, we look at lines of business, the correlation between contracts in similar lines of business or the correlation between lines of business that can be affected by the same sort of impact such as inflation or those sorts of things and we do a bottoms-up analysis of each of those contracts.

Alec Ofsevit – Credit Suisse

Okay. Thank you. And my second question on the underwriting side, you talked about your contract count being flat year-over-year. I guess, who do you see, where do you see you're gaining share with your existing clients? Are the larger European players pulling back or are clients diversifying from those companies?

Len Goldberg

Actually, as I think we described in the call, we're seeing a lot of opportunities from the same client base that we had in the year before. So, we're developing deeper relationships with the same clients that we've had rather than going outside those clients to find new business because pricing is a little bit difficult right now.

Alec Ofsevit – Credit Suisse

And I guess, can you just provide a quick update on what you see for the 1Q renewal activity?

Len Goldberg

I think we see more of the same, I don't think we see great new opportunities out there. But, I think we're very happy with the portfolio that we have and the businesses that we're in right now and the way that our clients help to defend our capital base.

Alec Ofsevit – Credit Suisse

Okay. Thank you. And just one final question on the investment side. I know you talked about your views on sovereign concerns but I guess I'm just curious if you see that as playing out or is that a more secular longer term thesis?

David Einhorn

Hi. This is David. I think that it's more of a secular long-term thesis. I don't know that we're anywhere near the end of this in view of whatever the current portfolio is.

I think things could get a little bit better. They could get worse. I don't think it'll go in any sort of a straight line but I do think that there is an intermediate term problem here that we need to be positioned for.

Alec Ofsevit – Credit Suisse

Okay. Great. Thank you very much, everybody.

Operator

Our next question comes from Ron Bobman of Capital Returns.

Ron Bobman – Capital Returns

Thanks. And good morning. I had just a couple of questions about Verdant. I was interested to know how much capital you've invested or capitalized Verdant with and why you chose to have it incorporated in the U.S.

And then, finally, is the Verdant capital or the Verdant portfolio subject to the DME sort of fee agreement, investment management agreement, as well? Thanks a lot.

Len Goldberg

Verdant is a very small entity. It's incorporated in the U.S. because its primary purpose is to make small strategic investments for us in the United States. So, the majority of those assets in Verdant are actually invested in other firms that we're doing business with. The investments are roughly $15 million currently.

Ron Bobman – Capital Returns

Okay. And then, how about, is that portfolio within the dollars there subject to the DME investment management agreement and the fees?

Len Goldberg

No. They're not.

Ron Bobman – Capital Returns

All right. Thanks a lot. And continued good luck.

Len Goldberg

Thank you.

Operator

(Operator Instructions) We have a question from Stewart Jackson [ph] of Southeast Asset Advisors.

Bernie Lanigan – Southeast Asset Advisors

Good morning. This is Bernie Lanigan. My question is related to the notes receivable. Is that receivable from the same companies that we've invested in?

Tim Courtis

Bernie, this is Tim Courtis. Yes, it is. Those are strategic investments.

Bernie Lanigan – Southeast Asset Advisors

So, we've got loans of some $14 million and then we've got equity investments and a minority interest of about the same?

Tim Courtis

I'm sorry. I don't understand the point on the minority interest.

Bernie Lanigan – Southeast Asset Advisors

Well, we have -- you just mentioned about the new company that was formed in the United States to make strategic investments. Is that the same strategic investments that we're making investments there, and also we're loaning them money?

Tim Courtis

Yeah. So, Verdant is a holding company domiciled in the U.S. And we make strategic investments, which could be in the form of an equity investment or as you noted the note receivable a debt investment. And the some of those two is what Verdant is strategically making those investments in.

Bernie Lanigan – Southeast Asset Advisors

Okay. Would we account for the profit or loss in the subsidiaries on an equity method?

Tim Courtis

It would depend on the form of the investment. Most of them are not controlling forms, so we would not be using equity accounting for those.

Bernie Lanigan – Southeast Asset Advisors

So, it would be used fair market value, obviously?

Tim Courtis

On a debt investment, we would be looking at…

Bernie Lanigan – Southeast Asset Advisors

No. Not on…

Tim Courtis

… debt.

Bernie Lanigan – Southeast Asset Advisors

I'm sorry, not...

Tim Courtis

Yeah, on any equity investment, we would be using a fair value for all, as we do with all of our investments.

Bernie Lanigan – Southeast Asset Advisors

I see. And so, would it be fair to say there has not been an unrealized gain or loss?

Tim Courtis

To date, that is correct.

Bernie Lanigan – Southeast Asset Advisors

And it's at cost.

Tim Courtis

Which we believe is the current fair market value, yes.

Bernie Lanigan – Southeast Asset Advisors

And what kind of, I mean, are we -- what interest rate are we charging on the notes?

Tim Courtis

They're various investments and so obviously, it depends upon the nature of the investments and where we stand in relationship to the total capital of the company and also the riskiest nature of it. So, it depends on the investment but we believe we're getting well compensated for the risk we're taking on those.

Bernie Lanigan – Southeast Asset Advisors

Would and you may not want to answer this for competitive reasons, obviously. But are you making these investments and these loans, are they P&C businesses that are writing the insurance for you or are they reinsurers, also?

Bart Hedges

This is Bart. And just to go back a couple calls, I guess, when we talked about some of the strategic investments. The investments that we've made are generally, we view them as very small dollar amounts of capital, be it a loan or equity in exchange for what we think are very large amounts of insurance opportunities.

And so, they are truly strategic investment in nature. They're helping us build the underwriting portfolio. While at the same time, we think we're getting very good returns on the capital, the hard capital that we're putting at risk.

Bernie Lanigan – Southeast Asset Advisors

I'm with you. Thank you.

Operator

This concludes our question and answer session today. Should you have any follow up questions, please direct them to Alex Stanton of Stanton Public Relations & Marketing at 212-780-0701, and he will be happy to assist you. We also remind you that a replay of this call and other pertinent information about Greenlight Re is available on our website at www.greenlightre.ky. Gentlemen, do you have any other closing remarks today?

Len Goldberg

No. We don't. Thank you for joining everybody.

Operator

Thank you for attending today's conference. You may now disconnect your lines.

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Source: Greenlight Capital Re, Ltd. Q4 2009 Earnings Call Transcript

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