Greenlight Capital Re, Ltd. Q2 2008 Earnings Call Transcript

| About: Greenlight Capital (GLRE)

Greenlight Capital Re, Ltd. (NASDAQ:GLRE)

Q2 2008 Earnings Call Transcript

August 7, 2008 9:00 am ET


Len Goldberg – CEO

David Einhorn – Chairman

Tim Courtis – CFO


Jim Bradshaw – Bares Capital Management

Brian Meredith – UBS


Good morning everyone and welcome to the Greenlight Capital Re second quarter 2008 earnings conference call. Joining us on the call this morning is David Einhorn, Chairman; Len Goldberg, Chief Executive 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 facts but rather reflect the company's current expectations, estimates, and predictions about future results and events, and are subject to risks, uncertainties, and assumptions 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 statement, whether as a result of new information, future events or otherwise.

Today's call is being recorded. All lines are in a listen-only mode and you will be given opportunity to ask questions following the company's remarks. I would now like to turn the call over to Mr. Len Goldberg.

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 this morning. The second quarter of 2008 continued to present the same challenges as the first quarter, namely a softening insurance and reinsurance market, combined with turbulent financial markets.

We generated net income of $33.5 million in the quarter or $0.92 per share on a fully diluted basis. Our book value over the last 12 months has increased by 9.4%. Given the current environment, we are pleased with this result, given we are still ramping up our reinsurance operations and the volatile equity markets.

Gross written premiums for the second quarter decreased significantly from the second quarter of 2007. One major difference was a multi-year severity account rebound in the second quarter of last year that will be earning premiums in the next three years, but had no additional recorded written premium in the second quarter.

The second major impact is that exposures on the 2008 contracts we have been on generally appear to becoming in lower than expected. If we were rooting for top line growth, we might be disappointed. However, it appears that a good number of our clients are protecting their interests and ours in a softening market; more on this later.

On the assets side, we generated positive results in a difficult quarter. Before discussing our second quarter performance in greater detail, I want to introduce our Chairman, David Einhorn, who will discuss our overall progress and recent investment results. David?

David Einhorn

Thanks, Lenny. First of all, I want to thank everyone who was able to join us at our first ever Investor Day in June. The Investor Day was well attended and we were able to further elaborate on our business strategy and progress to date. If you were not able to attend, you can find a replay of the event at the Greenlight Re Web site.

During the second quarter, the Greenlight Re investment account returned 4.5%. This brings our cumulative return from the investment portfolio to 3.6% for the first six months of the year during a period where the S&P declined 11.9%.

The portfolio performed well during the quarter in light of the challenging investment environment. The portfolio benefited from being long on few energy stocks and being short credit-sensitive financial and it was hurt primarily by some long financial exposure in consumer-sensitive needs.

Overall, the portfolio performed well while having average net long exposure for the quarter of 39%. While our goal is to preserve capital in difficult environment and generate attractive risk-adjusted absolute returns, there are environments where this goal is more difficult to achieve.

The current market poses real challenges to our strategy. It creates headwinds for our results. Momentum driven markets where cheap stocks get cheaper and expensive stocks with questionable prospects rise follow the difficulty to our value-oriented investment strategy. In our view, US markets are tenuous right now, if not downright scary. The market in the individual securities that comprise it are moving quickly and seem to be somewhat disconnected from fundamentals.

The good news is that many stocks are cheap. The bad news is that cheap stocks can get even cheaper. In times like these, we find it helpful to remind our investors and ourselves that we are focused on building positive returns over the long term.

The economy has the dual problem of high inflation and challenged consumer. The average consumer is over-levered, banks aren't lending, and the Fed's actions are aimed at helping things [ph] at the expense of almost everyone else.

The US has been through a period of poor monetary fiscal and trade policy combined with lax regulation in the financial sector. This has been exacerbated by the sellout by the credit rating agencies and the government focusing on bailing out investors of bad risk/reward decisions, which ultimately encourages worse behavior.

All of this has led to excessive leverage and credit and the excess is now unwinding. We became worried about this environment a year ago and positioned the portfolio accordingly. As we sit here today, we remain conservatively positioned. At the end of July, the Greenlight Re portfolio is approximately 93% gross long and 70% gross short. This is our highest gross short rate on record. We believe that problems remain in credit-sensitive financial companies and the unwind [ph] will continue for some time. We also think US consumer will be severely challenged over the coming months. Both of these views are expressed in our short portfolio.

On the long side, we own securities of unlevered companies with solid operating businesses trading at historically low multiples and cash flow and earnings. We believe that these companies will survive in the most difficult environment and the embedded value will prove out over the course of the cycle. In June and July, however, our long portfolio fell 16% after being about flat for the first five months of the year. This was partially mitigated by gains on short sales.

The management cap [ph] for Greenlight Re fell 6.6% in July bringing our year-to-date returns to negative 3.3%. We are displeased with this result. However, most of which appears to be a function of the bear market broadening coupled with a rally of financials. In the meantime, we will continue to do our best to preserve capital as the markets try to digest the tough times we're in.

Our program on both the investment and underwriting side is structured to weather difficult environments and to take advantage of the inefficiencies and opportunities they create. We believe our portfolio is attractive on current and prospective basis, so we recognize that only time will tell if that is correct.

On the underwriting side, we continue to be pleased with our measured growth in a softening pricing environment. Finding great opportunities continues to be a challenge but the team is finding good quality specialty opportunities where we can be value-added partners.

Now I’d like to turn the call back to Len to discuss Greenlight Re's underwriting portfolio, and in particular, a look at our frequency portfolio.

Len Goldberg

Thank you, David. On our last call, we talked extensively about how we measure catastrophe exposure and how important it is to look past the 99 percentile of the bell curve in managing and preserving capital. Our aggregate natural catastrophe exposures have continued to track slightly downward over the last several quarters.

Currently, we are still writing peak exposure retrocessional covers for a select group of clients and the pricing on this portfolio is holding up well. The largest of these contracts require multiple losses in order to attach to our cover, so there is some additional protection for us against a single sharp loss. We will continue to reduce natural catastrophe exposure if we believe that pricing and terms are not adequate.

For those of you that attended our June 3 Investor Day, our President and Chief Underwriting Officer, Bart Hedges, presented a couple of general examples of the types of deals that we found attractive and unattractive. One of Greenlight Re’s philosophies that Bart discussed is that we like to write specialty business with experts where we believe we can align our interests with the client. This is a core part of our strategy, the effects of which are becoming apparent in the second quarter of this year.

When we write frequency business through specialty carriers or underwriting managers, we are upfront with them, but we expect to only reimburse them for their expenses and reward them should the business generate positive economics. We do this because frequency business is lower margin business and one dead account can offset the profits of a number of good accounts. Because of our approach, we create rare profit sharing incentives for our clients, the direct result of which is that it protects their balance sheet and ours by writing less inadequately priced business in softening markets.

Another outcome of this approach is that there are many potential clients that prefer not to work with us. It’s a nice self-selecting mechanism. Let's use one example of a frequency account that has reduced exposure in protecting our balance sheet. This happens to be an underwriting manager with 35 years of experience in the commercial auto market. When we initially analyzed them under the deal, we thought pricing would come down 5% from the prior year due to soft market conditions. As of now, pricing is down 10% to 12%. If we were paying an override to the client with little or no profit sharing, he would have an incentive to write additional business to make up for the drop in price. This would disadvantage us and as not only would we have the expected business at worst pricing but also 10% to 12% more new business, which in the soft market performs even worse than the existing portfolio, a double whammy.

Trying to make profits in this scenario is like trying to jog in quicksand. Since we are paying the manager only his operating expenses, his results depend on writing profitable business. Our partner is protecting his profit sharing and our balance sheet as well in this softening market. We currently estimate that the premium generated from this account will be 35% less than we initially modeled. Backing out the reduction in price of 5 to 7 points worse than expected, our exposures are down over 25% from our initial pricing.

From our analysis, it is clear that our client is working hard to keep his best business while letting the more marginal business walk away. We believe that the end result is a smaller but higher quality portfolio that will be profitable for both of us. We will have also forged an excellent relationship with our client. And when the market for this product begins to turn around in the cycle, we will have the option to increase our exposure appropriately and we will be able to pay our client an even larger profit share.

In addition to the alignment of incentives, two other aspects of our strategy have come into play. First, since we write a concentrated reinsurance portfolio, we have excellent knowledge of what happens with each account and can quickly spot issues and make corrections where necessary. Second is our cradle-to-grave underwriting process, whereby the underwriter who bound the account continuously works with the client and handles their renewals. We believe this process increases cooperation and can mitigate some of the adversarial clashes that arise when trying to achieve a balance between profitability and premium production.

The overall effect of the softening market on our frequency business is to reduce premium writings but to maintain the underwriting economics. In the second quarter, premium is down largely from this phenomenon. We think this is appropriate. In the meantime, we are still actively looking for good business with the right clients and researching where the next market opportunities will develop.

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

Tim Courtis

Thanks, Lenny. Greenlight Re reported net income of $33.5 million for the second quarter of 2008 compared to net income of $21.3 million for the comparable period in 2007. On a fully diluted per-share basis, the profits for the three months ended June 30, 2008 was $0.92 per share compared to $0.76 per share for the second quarter of 2007. For the six months ended June 30, 2008, net income was $28.8 million compared to $8.2 million for the six months ended June 30, 2007. On a fully diluted per-share basis, net income was $0.79 per share compared to $0.33 per share for the comparable period in 2007.

For the second quarter of 2008, frequency business accounted for 82% of our gross written premiums which is consistent with the overall emphasis we placed on this business. As mentioned in previous quarters, for quota share frequency business, it takes longer for the ultimate premium on these contracts to be recorded. Due to our preference to write a small number of larger transactions, we expect that our mix of business between frequency and severity will fluctuate.

Premiums written during the second quarter of $25.4 million was down from $65.4 million of premium written during the second quarter of 2007. Lenny has mentioned a couple of reasons for this decrease. One other item of note is that premium from a large Florida homeowners quota share transaction which we wrote in 2007 was reduced by $4 million in the current quarter due to a significant number of policy cancellations. We do not believe this will materially affect the ultimate profitability on those accounts.

The composite ratio for our frequency business for the first six months of 2008 was 92.0% and 52.9 % for severity business, resulting in an overall composite ratio of 77.8%. This compares favorably to the reported overall composite ratio of 81.4% reported for the first six months of 2007. Once again, we must stress that our mix of business is continuously changing and as such our composite ratio during any particular period may be volatile.

Internal expenses for the six months ended June 30, 2008 were 14.7% of net premiums earned, resulting in a combined ratio of 92.5% for the first half of 2008. For the second quarter, we reported net investment income of $31.0 million, reflecting a net return of 4.5% on our investment account. We reported net investment income of $25.3 million during the first six months of 2008, reflecting a net investment return of 3.6%.

We continue to provide additional disclosures this quarter as required by SFAS 157 and 159 with respect to fair value measurements and the fair value option. Once again, it should be noted that approximately 97% of our investments in securities are classified as Level 1 under the standard and only $9 million, representing less than 2% of our investment portfolio, was invested in securities classified as Level 3 assets.

In our 10-Q, we mentioned that we ended a letter of credit agreement with UniCredit Bank, formerly Bank Austria Cayman. This was a small $25 million facility, and while no new letters of credit are being written out of this facility, all existing letters of credit will remain in force until they expire. The main reason for ending this facility was a strategic reorganization taken by UniCredit Bank to reduce certain services offered in the Cayman Islands. We still have significant unused capacity in our $400 million Citibank facility and we are actively pursuing additional letter of credit arrangements.

We held our annual general meeting on July 10, and at that meeting, the shareholders approved all of the proposals. In particular, shareholders approve the resolution removing restrictions in our articles of association requiring shareholder approval for share buybacks. In a subsequent board meeting on August 5, the Board adopted the share repurchase plan, authorizing the company to repurchase up to $2 million Class A ordinary shares. The decision to repurchase shares will depend on a number of variables. We believe this flexibility will allow us to actively manage our capital.

In closing, we want to once again stress our belief that long-term growth in fully diluted book value per share is our most important metric. When we look at the 12 months ended June 30, 2008, fully diluted book value per share increased to $17.29, up from $15.81 at June 30, 2007. This represents an increase of 9.4%.

I'll now turn the call back to Lenny who will provide some concluding remarks.

Len Goldberg

Thanks, Tim. The second quarter of 2008 continued the progress of Greenlight Re. Our reinsurance portfolio is beginning to mature and we are pleased thus far with the results. We have written a select number of contracts with properly aligned incentives and have picked some very good partners who are protecting our capital allowing us transact successfully in an increasingly difficult market.

Thanks again to everyone who participated in our Investor Day. We had a great time meeting everyone and we hope that we were able to provide some useful information.

And now, we would like to open the call up to questions.

Question-and-Answer Session


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

Jim Bradshaw – Bares Capital Management

Good morning. Congratulations on a nice quarter there. I was wondering if you could go into a little more detail about, you mentioned a number of variables as far as the buyback and when you would start to do some of that and just kind of how you think about that versus other uses of cash?

Len Goldberg

Yes. I don't think that one should expect that we would be getting repurchases and stock over time by any stretch of the imagination, but we want to have the flexibility in the case that market mistreats the stock in a way that we think creates an opportunity for the company to opportunistically repurchase shares from time to time.

Jim Bradshaw – Bares Capital Management

Okay. So you don't see yourself getting very aggressive certainly currently?

Len Goldberg

I'm not going to speculate exactly what it means – what I just said in great particulars because it will depend on whatever the facts and circumstances. But this is not a program where you look at it and you say, "Geez, there is $2 million shares that are authorized so it's over 12 quarters, so we would expect to purchase X number of shares in any particular quarter."

Jim Bradshaw – Bares Capital Management

Okay, all right. And then could you guys just talk briefly about what you're seeing competitive wise in the captive area?

Len Goldberg

As far as providing the insurance to captives?

Jim Bradshaw – Bares Capital Management


Len Goldberg

Captive purchasing is – there's a broad array of reasons for purchasing the insurance and those that are commoditized purchasers are able to find the reinsurance cheaper. We've been very lucky to find a small number of captive partners. We are looking for more of a long-term partnership.

Jim Bradshaw – Bares Capital Management

Okay. So you think things seem to be going – progressing pretty well there?

Len Goldberg

We think we are making some real headway into the Cayman captive market. It does require them to change their purchasing methodologies, because most do purchase currently in other markets besides Cayman but we are making some good headway.

Jim Bradshaw – Bares Capital Management

Great. Thanks for your time.


(Operator instructions) Your next question comes from the line of Brian Meredith with UBS.

Brian MeredithUBS

Good morning everybody. A couple of quick numbers questions here. First, Len, could you give us an update of which your NPL is (inaudible)?

Len Goldberg

I'm sorry. Brian, that was – it was hard to (inaudible).

Brian MeredithUBS

I’m sorry, can you hear me now?

Len Goldberg

Yes, you are just a little fuzzy, go ahead.

Brian MeredithUBS

I'm sorry. I was wondering if you could provide us what's your maximum loss is over cap, you used to typically provide that to us every quarter?

Len Goldberg

Sure, we're just looking into Q4 (inaudible) I'm sorry.

Brian MeredithUBS

Okay, and then the other one, I was wondering, how much were reserve releases in the quarter? I know you mentioned they were immaterial for the six months, but was there anything in the quarter?

Len Goldberg

We had a large reserve at least in the quarter on that harmonious account that Tim talked about but that does have a large profit sharing. As we mentioned in the call, we do like to buy an interest so there is a big reserve release in the quarter on that account, but the net effect on our balance sheet was relatively small.

Brian MeredithUBS

Thanks guys.

Len Goldberg

As far as the single loss events, the maximum average in any single loss is just under $52 million.

Brian MeredithUBS Securities

$52 million. Okay, great. And then, Len, could you talk a little more about – I'm just curious, the contract that you said that you had the $4 million – I guess reduction in premium from a lot of cancellations in the quarter, homeowners company, was it that the company just decided to pull out of the homeowners business or – I'm just a little confused as to what had happened there?

Len Goldberg

It's just some of the bunch of individual decisions from the homeowners themselves. A lot of them wind up canceling their cover and maybe they sold their house, maybe they found cheaper coverage elsewhere, but they had more late cancellations than we anticipated because it was a large account. The effect was actually quite large in the quarter.

Brian MeredithUBS

Got you. And then, David, I'm curious, you are talking about how your short position now is on a gross basis the largest, I guess, it has ever been. Where did you increase your kind of short exposure in your portfolio, was it with the financials area?

David Einhorn

Financial and outsource.

Brian MeredithUBS

Financials and outsource. So you're still pretty bears with respect to credit?

David Einhorn

Indeed, yes.

Brian MeredithUBS

Okay. Thanks.

David Einhorn

You're welcome.

Len Goldberg

Thanks Brian.


(Operator instructions) Sir, at this time, there are no further questions.

Len Goldberg



If 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. We also remind you that a replay of this call and other pertinent information about Greenlight RE is available on our website at Thank you. You may now disconnect.

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