Earnings Call Transcript - GLRE Q3 2020

Operator, Operator

Thank you for joining the Greenlight Re Conference Call for the Third Quarter of 2020 Earnings. 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 those enumerated in the company's Form 10-K/A for the year ended December 31, 2019, 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 differ 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, except as required by law. After the prepared remarks, we will be conducting a question-and-answer session. Please note, this event is being recorded. I would now like to turn the conference over to Greenlight Re's CEO, Mr. Simon Burton. Please go ahead, sir.

Simon Burton, CEO

Good morning, and thank you for joining our call today. Before we discuss our quarterly results, I'd like to provide some market context and what has been another stressful quarter for the reinsurance industry. In terms of loss activity in the quarter, it was unusual in two ways. First, there was a high frequency of small- to medium-sized natural catastrophes, including hurricanes, extreme on-land storms, and wildfires. Second, the ongoing pandemic is constantly adding to the body of potential industry loss exposure. The ultimate impact of losses incurred related to COVID-19 is still unknown as plaintiffs continue to test the insurers' positions on business interruption coverage in court with mixed success. Further uncertainties surround the ultimate duration of the pandemic, although a difficult winter in the Northern Hemisphere seems assured. So we are seeing reinsurance industry capital being removed by catastrophe losses and subject to loss and resulting uncertainty from COVID-19. In typical hard market conditions, we would see significant new capital into the market. In past years, we have seen rapid inflows of collateralized ILS capacity, effectively keeping a lid on runaway market pricing. This year, signs are pointing to investor fatigue with the ILS product having experienced four years of losses and an inability to redeploy capital that's encumbered by COVID-19 loss uncertainty. The new capital has been raised by startups and established reinsurers, but our assessment is that this new capital represents only a fraction of what's been lost or encumbered. The imbalance of reinsurance capital demand and supply is real, and the effects of market conditions will be significant. With that fairly complicated backdrop, I'm pleased with our performance this quarter as we reported a combined ratio of 100.4%. This underwriting result reflects discipline in both expense control and risk management, as well as increasing stability in our loss reserves. Excluding the impact of catastrophes, the underlying combined ratio of 93.4% reflects an underwriting business that is already well positioned to create shareholder value as industry losses revert to normal levels. As market conditions improved significantly into 2021, we expect our underwriting business to present an increasingly attractive risk-return proposition for our shareholders. This quarter, there was relatively little financial contribution from our strategic investments, although investment gains are all lumpy in this area of our business. Nevertheless, I can say with confidence that the overall basket of strategic investments has performed well through the pandemic conditions. Further, several of our innovation partners are benefiting from the surge of clients and investor interest in their products as the benefits of digital transactions become clearer in lockdown situations. We continue to see compelling new opportunities for early-stage strategic partnerships and expect further growth in this area of our business. Now I'd like to turn the call over to David.

David Einhorn, CIO

Thanks, Simon, and good morning, everyone. The Solasglas fund returned 1.4% in the third quarter. Longs contributed 3.1%, while shorts detracted 1.9%, and macro was slightly positive. During the quarter, the S&P 500 Index returned 8.9%. Long positions in Green Brick Partners and The Chemours Company were the biggest winners. Green Brick Partners shares advanced 36% in the third quarter as the company beat second-quarter consensus earnings estimates by a wide margin. Business momentum is accelerating as the combination of increased demand for single-family detached housing and low mortgage rates has contributed to a strong order rate and recent record backlog. Green Brick's high volume of sales has also contributed to higher profitability as operating expenses have remained stable. The company reported third quarter earnings per share of $0.69 last week, well ahead of expectations. Despite a sharp increase in the shares, they seem inexpensive at 8x 2021 consensus estimates. Chemours shares returned 38% in the third quarter, while earnings were challenged in the spring due to the impact of COVID-related lockdowns. Demand for paint has picked up as automotive production has come back online and is projected to surge in the coming quarters given the uptick in home construction and remodeling projects. As the global low-cost supplier of high-quality titanium dioxide, Chemours is well positioned to regain lost market share should demand remain strong in the coming quarters. Our Tesla short detracted from performance. The stock nearly doubled in the quarter, driven in part by a surge in retail investor flows following the company's announcement of a 5-for-1 stock split in August and a potential inclusion in the S&P 500 Index. We believe market behavior like this is emblematic of the mania surrounding a small universe of story and other tech stocks. It is our view that we are now in the early stages of the bubble popping. As a result, we have shorted a basket of high-flying stocks and recent IPOs trading at excessive valuations. Our long book contains businesses that are uniquely positioned to do well in this environment, such as Change Healthcare, which owns the largest medical claims clearinghouse and has benefited from a ramp-up in healthcare volumes as people have resumed elective procedures. And Atlas Air Worldwide Holdings, which owns and operates the world's largest fleet of freighters, with passenger travel down, there is a shortage of airfreight capacity and freighters like Atlas Air have been able to command a premium to ship commercial goods. Solasglas returned 2.1% in October, bringing the 2020 year-to-date result for Solasglas to negative 4.5%. Net exposure was approximately 17% long in the investment portfolio at the end of the third quarter and roughly 21% at the end of October. Our underwriting portfolio performed well during the third quarter despite catastrophes costing us 7 points of losses. The team is hard at work making preparations for a hard renewal market on January 1, 2021. And now I'd like to turn the call over to Neil to discuss the financial results.

Neil Greenspan, CFO

Thank you, David. Our fully diluted book value per share grew 1.9% during Q3, ending the quarter at $12.3. Net income for the quarter was $2.2 million or $0.06 per share, driven primarily by gains in our Solasglas portfolio that David described earlier. The company reported a small underwriting loss of $0.4 million during the quarter, and the combined ratio of 100.4%. The quarter's results included losses from Q3 catastrophic events of $8.1 million, which contributed 7 percentage points to the combined ratio. Our estimate of COVID-19 losses did not change, and we recognized a slight benefit from prior year development during the third quarter. Gross premiums were $134 million for the quarter, up 23% from the third quarter of 2019. The increase was due primarily to increases in the workers' compensation business and also in specialty lines, which include crop and energy contracts, as well as health business generated by our innovations initiatives. On a year-to-date basis, gross premiums written are down 15%, primarily as a result of our decision not to renew certain personal motor contracts. Total general and administrative expenses incurred during the quarter were $5.2 million, representing a decrease of $2.6 million or approximately 33% from the prior year period. This decrease was due primarily to lower stock compensation and other personnel costs, as well as the nonrecurrence of expenses related to our 2019 strategic review. We reported total net investment income of $6.9 million during the third quarter of 2020, which includes net investment income of $6.4 million on our investment in Solasglas. During the third quarter, we repurchased approximately 700,000 shares at an average cost of $6.87 per share, according to a discount of 43% of our September 30 fully diluted book value per share. Now I'll turn the call back to the operator and open it up to questions.

Operator, Operator

The first question is from Mikel Abasolo from Solo Capital Management.

Mikel Abasolo, Analyst

After the decision not to proceed with the sale of the insurance operation, do you still consider offers for that operation, or is that option no longer available? My second question may be technical, and I could be mistaken, but I understand that the hedge fund, Solasglas, is similar to another hedge fund, and I believe the hedge fund had a 7% increase in October compared to the 2.1% for Solasglas. They might not be comparable, but if that's the case, I would like some clarification. Lastly, I'm interested in the pace of buybacks. The shares are currently trading at 55% to 60% of book value, and you have significant capacity to increase buybacks, yet the pace seems slow. Could you explain what influences the pace of buybacks and the reasoning behind increasing them now versus in future years?

Simon Burton, CEO

Mikel, it's Simon here. So I'm going to tackle your questions one by one. And David may well want to add to this. So the strategic review that we announced earlier in 2019 concluded early this year, was a process that encompassed all options for the company, including a review of our operations, strategy, the potential for strategic transactions, partnerships, and potentially even the sale of the company. A sale was only a small part of what we were considering, but it was an all-encompassing strategic review. We concluded that process by determining that the company's go-forward strategy is the best option for our shareholders. For all the reasons you're hearing on the call today and the improving market conditions, we continue to be highly convinced that that's the right approach. Should a good idea come upon us in the future, whether it's a strategic transaction or potentially something that changes our landscape entirely, of course, we will consider it. That's our obligation, but it's not our focus at this point. The second question, the hedge fund being highly pursued, that is not always the case. Clearly, there are similarities between Solasglas and Greenlight Capital fund, but we diverge in certain ways because of certain risk constraints that the Board has asked Greenlight Capital to live within and also capital constraints in the company. So you shouldn't assume that Solasglas is an exact mirror of Greenlight Capital. The third on the buybacks. We are pleased to have been buying back shares at what we consider to be a severely discounted and mispriced stock. Having said that, there's a great deal of competition for our capital. We have a lot of good ideas for our capital, and we're obviously balancing those interests as we go forward.

David Einhorn, CIO

Yes, I’d like to add that regarding the difference in performance, for instance, the lower net exposure in Solasglas means the overall level of investment is less on a gross basis compared to the capital at the Greenlight hedge funds. Therefore, you can expect less volatility due to having a smaller balance sheet in relation to the company's capital at this time. As for the buyback, we are somewhat constrained by the trading volumes of the shares. We believe the shares are significantly undervalued, and utilizing capital for buybacks is an excellent strategy. As long as the company has sufficient capital that doesn’t impact our core business, repurchasing shares at these prices is the best use of additional capital. We will continue this approach until the shares recover.

Mikel Abasolo, Analyst

Okay. David, but you don't feel like the opportunity is now that you have to push it higher now that the discount is too wide?

David Einhorn, CIO

I think the discount is too wide, but there are limitations, for example, as a percentage of volume that buybacks can be, and we're operating within the constraints that are there. If you compare what we actually bought back during the quarter to the actual trading volumes of the stock during the quarter, I think you would see that we would be relatively aggressive.

Operator, Operator

The next question is from an unidentified analyst with Ocho Investments.

Unidentified Analyst, Analyst

Can you just help me understand the financial model that you expect longer term to provide basically a return to shareholders that meaningfully exceeds the market return? And I guess what I'm wondering is, like what level of combined ratio and what level of gross exposure do you expect the company to use longer term to outperform the market such that basically, it meaningfully outperforms the return of capital to shareholders at or approximately book value? But I guess I'm just wondering like the combined ratio and the gross exposure that is needed and how long it will be until you think you can operate at that level.

Simon Burton, CEO

Dris, it's Simon here. Our strategy is and has been from the inception of the company to combine high-quality reinsurance returns with high-quality investment returns. We believe that the combination of those two things presents a very compelling opportunity for our shareholders. Clearly, there are certain times in the marketplace where one or the other, or perhaps both of those theses are under stress. We've seen a mix of that in recent years. Of course, I'll let David comment, and you heard David extensively comment on the investment management landscape. From a reinsurance perspective, we're looking at the marketplace and market opportunity that exceeds conditions that many of us have seen in our career. Certainly, I don't recall since post 9/11 or even earlier. They're exceptionally good and improving all the time. We feel very well positioned to participate in that. Of course, we don't provide guidance on future performance of the underwriting business, but we feel very good about where we're positioned, about the strength of our balance sheet and reserves, and our ability to deploy capital into that significantly improved environment.

David Einhorn, CIO

I would just add to answer your question a little bit further. As we've done the planning for 2021, if we can get near our internal plan, we would achieve what you are suggesting next year.

Unidentified Analyst, Analyst

Meaning a return that exceeds cost of capital basically? Is that what you are interpreting?

David Einhorn, CIO

Yes. I think that the cost of capital is high right now given the implications of the stock price.

Unidentified Analyst, Analyst

Could you elaborate a bit more? David, you mentioned that share buybacks are the best use of capital. I'm trying to understand that statement in relation to a 70% risk-free return to shareholders. How do you view the possibility of using essentially all of your capital for that purpose by returning it to shareholders?

David Einhorn, CIO

Yes. We are not planning to liquidate the business and need to keep enough capital to avoid that situation. Additionally, we believe there are opportunities within the business that can yield sufficient returns on capital, especially given the rapidly improving market conditions. Regarding constraints, as I mentioned earlier, there are trading limitations related to the percentage of volume. Recently, about 8 million shares were traded in the last quarter, and our share repurchase accounted for approximately 9% of that trading volume. We face limitations due to these percentage of volume constraints. If there were a greater desire for selling stocks or trading them more quickly, we could likely repurchase shares at a faster pace.

Operator, Operator

The next question is from Suleman Soorani with Tricap Investments.

Suleman Soorani, Analyst

David, you mentioned about the divergence of performance between Solasglas and your hedge fund, and the reason is that the amount of capital that's used and I think the position that you're taking at Solasglas is not as aggressive as for the hedge fund. And if I remember correctly, I think maybe last quarter or the quarter before, you said that gradually, you will take it to the same position level as your hedge fund. So any insight into when we could expect that to happen? Because I remember last year or the year before when the capital position was strong, the returns of Solasglas or the funds managed for the insurance company used to very well largely depict the returns on the hedge fund. So any timeline as to when the divergence will reduce?

David Einhorn, CIO

Yes, last quarter, I indicated that we would aim to increase the amount, not completely align it. It seems there may have been a misunderstanding regarding my previous statement. As of September 30, we've already improved our investment levels compared to the hedge fund, but it's still significantly lower. This will remain the case until the Board decides to make a change, and I'm uncertain when that might occur. Additionally, we likely need to strengthen our capital within the company for that to take place.

Suleman Soorani, Analyst

Sure. Regarding the extent of divergence, should we expect that this quarter, the return for Solasglas is about 2% while the hedge fund exceeded 7%, indicating a significant divergence of more than double? Is that what we should anticipate moving forward, or will it also change?

David Einhorn, CIO

It should be somewhat less than that. There's one particular position in Green Brick Partners, which has an outsized weighting in the hedge fund. At Solasglas, that is constrained by the investment guidelines that we have. Our best-performing position, although it was a very large contributor to Solasglas, was more underweight there than some other things within the funds, and that contributed to the divergence.

Operator, Operator

This concludes our question-and-answer session. Should you have any follow-up questions, please direct them to Adam Prior of the Equity Group, Inc. at 212-836-9606, 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.com. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.