Greenlight Capital Re, Ltd. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Financial amounts are in U.S. dollars; amounts below are in millions unless noted. Greenlight Re is a specialty property and casualty reinsurer, with results affected by underwriting experience and a value-oriented long/short investment portfolio.
Financial performance and position
- Q2 results: Net loss was $39.6 million, or $1.06 per share, versus net income of $109.6 million, or $2.94 per share, in Q2 2014. Total revenue fell to $67.6 million from $200.4 million, principally reflecting a swing from $113.9 million of investment income to a $20.3 million investment loss.
- First-half results: Net loss was $63.6 million, or $1.71 per share, versus net income of $100.7 million, or $2.71 per share, in the first half of 2014. Total revenue was $139.2 million, down from $302.1 million; net investment loss was $45.1 million compared with $103.8 million of investment income.
- Underwriting: First-half net premiums earned were $186.5 million, down from $199.5 million. Net losses incurred rose to $139.9 million from $124.0 million, while acquisition costs declined to $50.8 million from $63.4 million. The six-month composite ratio was 102.2% versus 93.9%; the combined ratio, including general and administrative expenses, was 109.2% versus 99.8%. A ratio above 100% indicates underwriting losses.
- Investment returns: The DME-managed portfolio returned negative 1.5% in Q2 and negative 3.2% for the first half, compared with positive 8.1% and 7.3%, respectively, in 2014. First-half short and macro positions detracted, partly offset by gains on long positions. No performance allocation was recorded in 2015 due to investment losses; management fees were $10.4 million for the first half.
- Balance sheet at June 30: Total assets were $3.425 billion and total equity was $1.127 billion, compared with $2.995 billion and $1.194 billion at December 31, 2014. Adjusted book value per share, a non-GAAP measure, was $29.07 fully diluted, down 5.5% from year-end; basic adjusted book value per share was $29.34, down 5.9%.
- Cash and liquidity: Cash and cash equivalents were $91.0 million; restricted cash was $1.649 billion, up from $1.297 billion at year-end, and is largely pledged as collateral. Operating cash flow was negative $14.8 million for the first half, compared with negative $39.1 million in 2014; investing activities provided $98.0 million, primarily reflecting increased prime-broker borrowing. Management said it expects liquidity to meet foreseeable needs and plans to fund the next 12 months from operating cash flow.
- Borrowings and collateral: “Due to prime brokers” totaled $515.1 million, up from $211.1 million at year-end. This included $212.7 million for investment purchases and $302.3 million borrowed to collateralize letters of credit. The company had $720 million of letter-of-credit capacity, with $299 million issued and $416.1 million of assets pledged as collateral.
Material changes versus the prior comparable period
- Gross premiums written increased 46% to $222.7 million for the first half, while net premiums earned decreased about 7%. Growth in motor, professional liability, health, and new quota-share contracts was partly offset by reduced Florida homeowners’ premiums and non-renewed catastrophe retrocession business.
- Underwriting deteriorated, chiefly due to $14.7 million of adverse development on a general liability contract in run-off. The company increased estimated average loss cost per claim following updated information and actuarial review. Florida homeowners’ losses also developed adversely, including sinkhole deterioration and water-damage claims.
- Loss reserves increased to $270.4 million from $264.2 million at year-end. First-half adverse development on prior-period contracts was $16.9 million, partly offset by favorable developments and commission adjustments.
- Short securities sold, not yet purchased rose 17.8% to $1.285 billion; reported short exposure increased to 83.3% from 66.9% at year-end. Long exposure was 104.2%, down from 105.8%; net long exposure was 20.9%.
- Notes receivable increased to $29.9 million from $1.6 million after a ceding-insurer settlement converted receivables into a ten-year note. Of the June balance, $24.8 million was on non-accrual status. The company stated management expected the recorded notes to be collectible.
Outlook, risks, contingencies, and unusual items
- Management gave no numerical earnings or premium guidance. It expects competitive conditions and excess industry capital to pressure pricing, particularly for peak-zone catastrophe excess-of-loss business. It may maintain or reduce premium writings rather than accept risks it considers mispriced, while pursuing customized and capacity-constrained opportunities.
- The investment objective for 2015 is capital protection and positive returns. Management expected to continue holding significant gold, foreign-exchange options, sovereign-debt shorts, and sovereign credit-default swaps. It cautioned that underwriting and investment results may vary substantially and historical returns may not predict future results.
- Market risks include equity, commodity, currency, interest-rate, credit, political, and short-sale risks. A 10% fall in listed equity and equity-derivative prices was estimated to reduce portfolio fair value by $24.4 million; a 10% fall in gold was estimated to reduce it by $13.8 million. Short positions can have theoretically unlimited loss potential.
- Greek exchange-traded securities were transferred to Level 3 fair-value classification after trading on the Athens Stock Exchange was halted. Values relied on adjusted last-trade prices and other estimates; associated derivatives also used unobservable inputs.
- Natural-peril exposure as of July 1, 2015 was reported at a maximum aggregate $268.5 million, net of retrocession and reinstatement premiums. Retrocessionaires’ failure to pay could leave the company responsible for claims; the company reported $2.9 million of recoverables from unrated retrocessionaires and no required provision for uncollectibility.
- Management reported compliance with letter-of-credit covenants and regulatory minimum capital requirements. The subsidiaries’ “A (Excellent)” A.M. Best ratings are important to writing new business; a downgrade below “A-” or withdrawal could significantly restrict underwriting capacity.
- The filing highlights proposed U.S. tax-rule changes and legislation that could affect whether the company qualifies for the foreign-insurance-company exception to PFIC rules, potentially materially affecting U.S. shareholders and requiring changes to operations. The company said the outcome was uncertain.
- Other notable items: 140,000 Class A shares were repurchased during the first half at an average Q2 price of $30.28; another 360,000 shares were repurchased through August 1 at an average $28.95. A specialist service agreement was scheduled to terminate September 1, 2015, with $0.6 million of minimum post-termination payments. Management said existing disputes were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the $14.7 million general-liability reserve strengthening and other adverse development are sufficient, and how claims experience changes in subsequent periods.
- Collection and impairment status of the $24.8 million non-accrual notes receivable, including the ten-year ceding-insurer settlement note.
- Investment performance, valuation assumptions for Level 3 assets, and liquidity/collateral demands under the short and derivative positions.
- Prime-broker borrowing, restricted-cash requirements, and letter-of-credit capacity and covenant compliance as exposures change.
- Developments in U.S. PFIC rules and legislation, and any effect on U.S. shareholders or the company’s business structure.
- Whether premium growth translates into earned premiums and profitable underwriting, given the 102.2% first-half composite ratio and management’s selective-writing approach.