XMEX:GLRE Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
__________________________
FORM 10-Q 
__________________________
(Mark One)
 x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the quarterly period ended June 30, 2012

or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
For the transition period from         to
Commission file number 001-33493
____________________________________________________________________________________
GREENLIGHT CAPITAL RE, LTD.
(Exact name of registrant as specified in its charter)
____________________________________________________________________________________
CAYMAN ISLANDS
N/A
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification no.)
 
65 MARKET STREET
SUITE 1207, CAMANA BAY
P.O. BOX 31110
GRAND CAYMAN
CAYMAN ISLANDS
 
 
 
 
KY1-1205
(Address of principal executive offices)
(Zip code)

(345) 943-4573
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report) 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)            Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 
Yes ¨ No x

Class A Ordinary Shares, $0.10 par value
30,423,704
Class B Ordinary Shares, $0.10 par value
6,254,949
(Class)                      
(Outstanding as of July 27, 2012)





GREENLIGHT CAPITAL RE, LTD.
 
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
Quantitative and Qualitative Disclosures about Market Risk                                                                                                              
Controls and Procedures                                                                                                           
Legal Proceedings                                                                                                          
Risk Factors                                                                                                               
Unregistered Sales of Equity Securities and Use of Proceeds                                                      
Defaults Upon Senior Securities                                                                                                               
Other Information                                                                                                               
Exhibits                                                                                                               



 

2


PART I — FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS 
GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
June 30, 2012 and December 31, 2011
(expressed in thousands of U.S. dollars, except per share and share amounts)
 
June 30, 2012
 
December 31, 2011
 
(unaudited)
 
(audited)
Assets
 
 
 
Investments
 
 
 
Debt instruments, trading, at fair value
$
9,088

 
$
10,639

Equity securities, trading, at fair value
1,058,729

 
890,822

Other investments, at fair value
138,513

 
128,685

Total investments
1,206,330

 
1,030,146

Cash and cash equivalents
11,262

 
42,284

Restricted cash and cash equivalents
922,889

 
957,462

Financial contracts receivable, at fair value
23,972

 
23,673

Reinsurance balances receivable
179,958

 
141,278

Loss and loss adjustment expenses recoverable
36,911

 
29,758

Deferred acquisition costs, net
60,321

 
68,725

Unearned premiums ceded
11,929

 
27,233

Notes receivable
19,082

 
17,437

Other assets
4,755

 
5,492

Total assets
$
2,477,409

 
$
2,343,488

Liabilities and equity
 
 
 
Liabilities
 
 
 
Securities sold, not yet purchased, at fair value
$
663,542

 
$
683,816

Financial contracts payable, at fair value
12,972

 
6,324

Due to prime brokers
365,007

 
260,359

Loss and loss adjustment expense reserves
294,647

 
241,279

Unearned premium reserves
208,766

 
225,735

Reinsurance balances payable
37,947

 
32,192

Funds withheld
33,185

 
38,031

Other liabilities
7,777

 
10,054

Performance compensation payable to related party
7,870



Total liabilities
1,631,713

 
1,497,790

Equity
 
 
 
Preferred share capital (par value $0.10; authorized, 50,000,000; none issued)

 

Ordinary share capital (Class A: par value $0.10; authorized, 100,000,000; issued and outstanding, 30,423,704 (2011: 30,283,200): Class B: par value $0.10; authorized, 25,000,000; issued and outstanding, 6,254,949 (2011: 6,254,949))
3,668

 
3,654

Additional paid-in capital
490,215

 
488,478

Retained earnings
340,035

 
310,971

Shareholders’ equity attributable to shareholders
833,918

 
803,103

Non-controlling interest in joint venture
11,778

 
42,595

Total equity
845,696

 
845,698

Total liabilities and equity
$
2,477,409

 
$
2,343,488

 
  The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements.

3


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
 
For the three and six months ended June 30, 2012 and 2011
(expressed in thousands of U.S. dollars, except per share and share amounts)
 
Three months ended June 30,
 
Six months ended June 30,
 
2012
 
2011
 
2012
 
2011
Revenues
 
 

 
 
 
 
Gross premiums written
$
83,986

 
$
113,266

 
$
236,206

 
$
214,005

Gross premiums ceded
4,602

 
(17,183
)
 
(6,393
)
 
(20,659
)
Net premiums written
88,588

 
96,083

 
229,813

 
193,346

Change in net unearned premium reserves
41,426

 
11,068

 
1,789

 
18,962

Net premiums earned
130,014

 
107,151

 
231,602

 
212,308

Net investment income (loss)
(36,896
)
 
(19,469
)
 
34,711

 
(55,645
)
Other income (expense), net
(236
)
 
(86
)
 
(448
)
 
(347
)
Total revenues
92,882

 
87,596

 
265,865

 
156,316

Expenses
 
 

 
 
 

Loss and loss adjustment expenses incurred, net
87,337

 
56,870

 
150,644

 
122,595

Acquisition costs, net
37,905

 
42,824

 
73,930

 
84,945

General and administrative expenses
4,359

 
4,336

 
8,982

 
9,335

Total expenses
129,601

 
104,030

 
233,556

 
216,875

Income (loss) before income tax expense
(36,719
)
 
(16,434
)
 
32,309

 
(60,559
)
Income tax benefit (expense)
201

 
(40
)
 
(62
)
 
(41
)
Net income (loss) including non-controlling interest
(36,518
)
 
(16,474
)
 
32,247

 
(60,600
)
(Income) loss attributable to non-controlling interest in joint venture
449

 
513

 
(3,183
)
 
1,649

Net income (loss)
$
(36,069
)
 
$
(15,961
)
 
$
29,064

 
$
(58,951
)
Earnings (loss) per share
 
 

 
 
 

Basic
$
(0.98
)
 
$
(0.44
)
 
$
0.80

 
$
(1.63
)
Diluted
$
(0.98
)
 
$
(0.44
)
 
$
0.78

 
$
(1.63
)
Weighted average number of ordinary shares used in the determination of earnings (loss) per share
 
 

 
 
 

Basic
36,660,267

 
36,153,743

 
36,605,610

 
36,153,743

Diluted
36,660,267

 
36,153,743

 
37,338,484

 
36,153,743

 

 
The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 


 
 

4


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(UNAUDITED)
 
For the six months ended June 30, 2012 and 2011
(expressed in thousands of U.S. dollars)

 
Ordinary share capital
 
Additional paid-in capital
 
Retained earnings
 
Shareholders' Equity Attributable to Shareholders
 
Non-controlling
interest in joint venture
 
Total Equity
Balance at December 31, 2010
$
3,646

 
$
485,555

 
$
304,202

 
$
793,403

 
$
45,758

 
$
839,161

Issue of Class A ordinary shares, net of forfeitures
12

 

 

 
12

 

 
12

Share-based compensation expense, net of forfeitures

 
2,012

 

 
2,012

 

 
2,012

Non-controlling interest withdrawal from joint venture, net

 

 

 

 
(10,400
)
 
(10,400
)
Income (loss) attributable to non-controlling interest in joint venture

 

 

 

 
(1,649
)
 
(1,649
)
Net income (loss)

 

 
(58,951
)
 
(58,951
)
 

 
(58,951
)
Balance at June 30, 2011
$
3,658

 
$
487,567

 
$
245,251

 
$
736,476

 
$
33,709

 
$
770,185

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2011
$
3,654

 
$
488,478

 
$
310,971

 
$
803,103

 
$
42,595

 
$
845,698

Issue of Class A ordinary shares, net of forfeitures
14

 

 

 
14

 

 
14

Share-based compensation expense, net of forfeitures

 
1,737

 

 
1,737

 

 
1,737

Non-controlling interest withdrawal from joint venture, net

 

 

 

 
(34,000
)
 
(34,000
)
Income (loss) attributable to non-controlling interest in joint venture

 

 

 

 
3,183

 
3,183

Net income (loss)

 

 
29,064

 
29,064

 

 
29,064

Balance at June 30, 2012
$
3,668

 
$
490,215

 
$
340,035

 
$
833,918

 
$
11,778

 
$
845,696



The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 


 

5


GREENLIGHT CAPITAL RE, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the six months ended June 30, 2012 and 2011
(expressed in thousands of U.S. dollars)
 
 
Six months ended June 30,
 
2012
 
2011
Cash provided by (used in) operating activities
 
 
 
Net income (loss) 
29,064

 
(58,951
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
 
 

Net change in unrealized gains and losses on investments and financial contracts
(62,309
)
 
92,833

Net realized (gains) losses on investments and financial contracts
5,513

 
(57,394
)
Foreign exchange (gains) losses on restricted cash and cash equivalents
1,208

 
7,630

Income (loss) attributable to non-controlling interest in joint venture
3,183

 
(1,649
)
Share-based compensation expense, net of forfeitures
1,751

 
2,024

Depreciation expense
125

 
112

Net change in
 
 

Reinsurance balances receivable
(38,680
)
 
(8,862
)
Loss and loss adjustment expenses recoverable
(7,153
)
 
(3,260
)
Deferred acquisition costs, net
8,404

 
6,764

Unearned premiums ceded
15,304

 
(10,735
)
Other assets
612

 
(1,590
)
Loss and loss adjustment expense reserves
53,368

 
32,151

Unearned premium reserves
(16,969
)
 
(8,068
)
Reinsurance balances payable
5,755

 
7,988

Funds withheld
(4,846
)
 
4,364

Other liabilities
(2,277
)
 
(1,413
)
Performance compensation payable to related party
7,870

 

Net cash (used in) provided by operating activities
(77
)
 
1,944

Investing activities
 
 

Purchases of investments and financial contracts
(809,588
)
 
(800,629
)
Sales of investments and financial contracts
676,275

 
727,485

Change in due to prime brokers
104,648

 
36,421

Change in restricted cash and cash equivalents, net
33,365

 
13,000

Change in notes receivable, net
(1,645
)
 
(3,750
)
Non-controlling interest withdrawal from joint venture
(34,000
)
 
(10,400
)
Net cash used in investing activities
(30,945
)
 
(37,873
)
Net decrease in cash and cash equivalents
(31,022
)
 
(35,929
)
Cash and cash equivalents at beginning of the period
42,284

 
45,540

Cash and cash equivalents at end of the period
11,262

 
9,611

Supplementary information
 
 

Interest paid in cash
13,796

 
9,203

Interest received in cash
498

 
876

Income tax paid in cash

 
144


The accompanying Notes to the Condensed Consolidated Financial Statements are an
integral part of the Condensed Consolidated Financial Statements. 

6


GREENLIGHT CAPITAL RE, LTD.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
June 30, 2012
 
 
1.   ORGANIZATION AND BASIS OF PRESENTATION
 
Greenlight Capital Re, Ltd. (‘‘GLRE”) was incorporated as an exempted company under the Companies Law of the Cayman Islands on July 13, 2004. GLRE’s principal wholly-owned subsidiary, Greenlight Reinsurance, Ltd. (‘‘Greenlight Re”), provides global specialty property and casualty reinsurance. Greenlight Re has an unrestricted Class ‘‘B” insurance license under Section 4(2) of the Cayman Islands Insurance Law. Greenlight Re commenced underwriting in April 2006. Effective May 30, 2007, GLRE completed an initial public offering of 11,787,500 Class A ordinary shares at $19.00 per share. Concurrently, 2,631,579 Class B ordinary shares of GLRE were sold at $19.00 per share in a private placement offering.  During 2008, Verdant Holding Company, Ltd. (‘‘Verdant”), a wholly owned subsidiary of GLRE, was incorporated in the state of Delaware. During 2010, GLRE established Greenlight Reinsurance Ireland, Ltd. ("GRIL"), a wholly-owned reinsurance subsidiary based in Dublin, Ireland. GRIL provides multi-line property and casualty reinsurance capacity to the European broker market and provides GLRE with an additional platform to serve clients located in Europe and North America.  As used herein, the ‘‘Company” refers collectively to GLRE and its subsidiaries.
 
The Class A ordinary shares of GLRE are listed on Nasdaq Global Select Market under the symbol ‘‘GLRE”.

These unaudited condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2011. In the opinion of management, these unaudited condensed consolidated financial statements reflect all of the normal recurring adjustments considered necessary for a fair presentation of the Company’s financial position and results of operations as of the dates and for the periods presented.
The results for the six months ended June 30, 2012 are not necessarily indicative of the results expected for the full calendar year.

2.   SIGNIFICANT ACCOUNTING POLICIES
 
Use of Estimates
 
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the period. Actual results could differ from these estimates. 
 
Restricted Cash and Cash Equivalents
 
The Company is required to maintain certain cash in segregated accounts with prime brokers and derivative counterparties. The amount of restricted cash held by prime brokers is primarily used to support the liability created from securities sold, not yet purchased, and for collateralizing the letters of credit issued under certain letter of credit facilities (see Notes 4 and 8). The amount of cash encumbered varies depending on the market value of the securities sold, not yet purchased, and letters of credit issued. In addition, derivative counterparties require cash collateral to support the current value of any amounts that may be due to the counterparty based on the value of the underlying financial instrument. 
 
Deferred Acquisition Costs
 
Policy acquisition costs, such as commission and brokerage costs, relate directly to, and vary with, the writing of reinsurance contracts. Acquisition costs relating solely to bound contracts are deferred subject to ultimate recoverability and are amortized over the related contract term. The Company evaluates the recoverability of deferred acquisition costs by determining if the sum of future earned premiums and anticipated investment income is greater than the expected future claims

7


and expenses. If a loss is probable on the unexpired portion of policies in force, a premium deficiency loss is recognized. At June 30, 2012 and December 31, 2011, the deferred acquisition costs were considered fully recoverable and no premium deficiency loss was recorded. 

Acquisition costs also include profit commissions which are expensed when incurred. Profit commissions are calculated and accrued based on the expected loss experience for contracts and recorded when the current loss estimate indicates that a profit commission is probable under the contract terms. As of June 30, 2012, $9.1 million (December 31, 2011: $10.1 million) of profit commission reserves were included in reinsurance balances payable on the condensed consolidated balance sheets. For the three and six months ended June 30, 2012, $0.3 million and $0.3 million (2011: $2.2 million and $2.6 million) of net profit commission expenses were included in acquisition costs, respectively, on the condensed consolidated statements of income.
  
Loss and Loss Adjustment Expense Reserves and Recoverable
 
The Company establishes reserves for contracts based on estimates of the ultimate cost of all losses including losses incurred but not reported ("IBNR"). These estimated ultimate reserves are based on the Company’s own actuarial estimates derived from reports received from ceding companies, industry data and historical experience. These estimates are reviewed by the Company periodically on a contract by contract basis and adjusted as necessary. Since reserves are estimates, the final settlement of losses may vary from the reserves established and any adjustments to the estimates, which may be material, are recorded in the period they are determined.
 
Loss and loss adjustment expenses recoverable include the amounts due from retrocessionaires for paid and unpaid loss and loss adjustment expenses on retrocession agreements. Ceded losses incurred but not reported are estimated based on the Company’s actuarial estimates. These estimates are reviewed periodically and adjusted when deemed necessary. The Company may not be able to ultimately recover the loss and loss adjustment expense recoverable amounts due to the retrocessionaires’ inability to pay. The Company regularly evaluates the financial condition of its retrocessionaires and records provisions for uncollectible reinsurance expenses recoverable when recovery is no longer probable.
 
Notes Receivable
 
Notes receivable include promissory notes receivable from third party entities. These notes are recorded at cost along with accrued interest, if any, which approximates the fair value. The Company regularly reviews all notes receivable individually for impairment and records provisions for uncollectible and non-performing notes. The Company places notes on non-accrual status when the value of the note is not considered impaired but there is uncertainty as to the collection of interest based on the terms of the note. The Company resumes accrual of interest on a note when none of the principal or interest remains past due or outstanding, and the Company expects to collect the remaining contractual principal and interest. Interest collected on notes that are placed on non-accrual status is treated on a cash-basis and recorded as interest income when collected, provided that the recorded value of the note is deemed to be fully collectible. Where doubt exists as to the collectability of the remaining recorded value of the notes placed on non-accrual status, any payments received are applied to reduce the recorded value of the notes. At June 30, 2012 and December 31, 2011, no interest was received relating to the notes placed on non-accrual status.
 
For the six months ended June 30, 2012, the notes earned interest at annual interest rates ranging from 6.0% to 15.0% and had maturity terms ranging from approximately 2 years to 7 years. At June 30, 2012, included in the notes receivable balance was $16.5 million (December 31, 2011: $16.5 million), related to notes placed on non-accrual status based on expectations of the Company’s ability to collect any further interest that would accrue up to maturity. At June 30, 2012, included in the notes receivable balance was $2.0 million of accrued interest (December 31, 2011: $2.0 million).
 
Based on management’s assessment, the recorded values of the notes at June 30, 2012 and December 31, 2011, were expected to be fully collectible and therefore no provision for uncollectible amounts was deemed necessary at June 30, 2012 and December 31, 2011. Interest income earned on notes receivable is included under net investment income in the condensed consolidated statements of income.

Deposit Assets and Liabilities
 
In accordance with U.S. GAAP, deposit accounting is used in the event that a reinsurance contract does not transfer sufficient risk, or a contract provides retroactive reinsurance. Any losses on such contracts are charged to earnings immediately. Any gains relating to such contracts are deferred and amortized over the estimated remaining settlement period. All such deferred gains are included in reinsurance balances payable in the condensed consolidated balance sheets. Amortized gains are recorded in the condensed consolidated statements of income as other income. At June 30, 2012, included in the condensed

8


consolidated balance sheets under reinsurance balances receivable and reinsurance balances payable were $5.2 million and $1.2 million of deposit assets and deposit liabilities (December 31, 2011: $4.7 million and $1.1 million), respectively. For the three and six months ended June 30, 2012, $0.2 million and $0.4 million was included in other income (expense), net, relating to losses on deposit accounted contracts (2011: $0.2 million and $0.5 million), respectively. There was no gain on deposit accounted contracts recorded for the three and six months ended June 30, 2012 and 2011.
 
Fixed Assets
 
Fixed assets are included in other assets on the condensed consolidated balance sheets and are recorded at cost. Fixed assets are comprised of computer software, furniture and fixtures and leasehold improvements and are depreciated, using the straight-line method, over their estimated useful lives, which are five years for both computer software, and furniture and fixtures. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or remaining lease term. 

At June 30, 2012, the cost, accumulated depreciation and net book values of the fixed assets were as follows:
 
Cost
 
Accumulated depreciation
 
 
Net book value
 
($ in thousands)
Computer software
$
200

 
$
(200
)
 
$

Furniture and fixtures
451

 
(187
)
 
264

Leasehold improvements
1,487

 
(412
)
 
1,075

Total
$
2,138

 
$
(799
)
 
$
1,339

 
At December 31, 2011, the cost, accumulated depreciation and net book values of the fixed assets were as follows:

Cost
 
Accumulated depreciation
 
 
Net book value
 
($ in thousands)
Computer software
$
200

 
$
(200
)
 
$

Furniture and fixtures
451

 
(142
)
 
309

Leasehold improvements
1,487

 
(332
)
 
1,155

Total
$
2,138

 
$
(674
)
 
$
1,464

 
The Company periodically reviews fixed assets that have finite lives, and that are not held for sale, for impairment by comparing the carrying value of the assets to their estimated future undiscounted cash flows. For the six months ended June 30, 2012 and the year ended December 31, 2011, there were no impairments in fixed assets.

Financial Instruments
 
Investments in Securities and Investments in Securities Sold, Not Yet Purchased
 
The Company’s investments in debt instruments and equity securities that are classified as “trading securities” are carried at fair value. The fair values of the listed equity investments are derived based on quoted prices (unadjusted) in active markets for identical assets (Level 1 inputs). The fair values of listed equities that have restrictions on sale or transfer which expire within one year, are determined by adjusting the observed market price of the equity using a liquidity discount based on observable market inputs. The fair values of debt instruments are derived based on inputs that are observable, either directly or indirectly, such as market maker or broker quotes reflecting recent transactions (Level 2 inputs), and are generally derived based on the average of multiple market maker or broker quotes which are considered to be binding. Where quotes are not available, debt instruments are valued using cash flow models using assumptions and estimates that may be subjective and non-observable (Level 3 inputs).

The Company’s “other investments” may include investments in private and unlisted equity securities, limited partnerships, and commodities, which are all carried at fair value. The fair values of commodities are determined based on quoted prices in active markets for identical assets (Level 1). The Company maximizes the use of observable direct or indirect inputs (Level 2 inputs) when deriving the fair values for “other investments”. For limited partnerships and private and unlisted equity securities, where observable inputs are not available, the fair values are derived based on unobservable inputs (Level 3

9


inputs) such as management’s assumptions developed from available information using the services of the investment advisor, including the most recent net asset values obtained from the funds’ managers.

For securities classified as “trading securities”, and “other investments”, any realized and unrealized gains or losses are determined on the basis of the specific identification method (by reference to cost or amortized cost, as appropriate) and included in net investment income in the condensed consolidated statements of income.

Dividend income and expense are recorded on the ex-dividend date. The ex-dividend date is the date as of when the underlying security must have been traded to be eligible for the dividend declared. Interest income and interest expense are recorded on an accrual basis.
 
Derivative Financial Instruments
 
U.S. GAAP requires that an entity recognize all derivatives in the balance sheet at fair value. It also requires that unrealized gains and losses resulting from changes in fair value be included in income or comprehensive income, depending on whether the instrument qualifies as a hedge transaction, and if so, the type of hedge transaction. The Company’s derivative financial instrument assets are included in financial contracts receivable. Derivative financial instrument liabilities are generally included in financial contracts payable. The Company's derivatives do not qualify as hedges for financial reporting purposes. 
 
Financial Contracts

The Company enters into financial contracts with counterparties as part of its investment strategy. Financial contracts which include total return swaps, credit default swaps (“CDS”), futures, options, currency forwards and other derivative instruments are recorded at their fair value with any unrealized gains and losses included in net investment income in the condensed consolidated statements of income. Financial contracts receivable represents derivative contracts whereby the Company is entitled to receive payments upon settlement of the contract. Financial contracts payable represents derivative contracts whereby the Company is obligated to make payments upon settlement of the contract.
 
Total return swap agreements, included on the condensed consolidated balance sheets as financial contracts receivable and financial contracts payable, are derivative financial instruments whereby the Company is either entitled to receive or obligated to pay the product of a notional amount multiplied by the movement in an underlying security, which the Company does not own, over a specified time frame. In addition, the Company may also be obligated to pay or receive other payments based on interest rates, dividend payments and receipts, or foreign exchange movements during a specified period. The Company measures its rights or obligations to the counterparty based on the fair value movements of the underlying security together with any other payments due. These contracts are carried at fair value, based on observable inputs (Level 2 inputs) with the resultant unrealized gains and losses reflected in net investment income in the condensed consolidated statements of income. Additionally, any changes in the value of amounts received or paid on swap contracts are reported as a gain or loss in net investment income in the condensed consolidated statements of income.
 
Financial contracts may also include exchange traded futures or options contracts that are based on the movement of a particular index, commodity, currency or interest rate. Where such contracts are traded in an active market, the Company’s obligations or rights on these contracts are recorded at fair value measured based on the observable quoted prices of the same or similar financial contract in an active market (Level 1) or on broker quotes which reflect market information based on actual transactions (Level 2). Amounts invested in exchange traded and over the counter (“OTC”) call and put options are recorded as an asset or liability at inception. Subsequent to initial recognition, unexpired exchange traded option contracts are recorded at fair value based on quoted prices in active markets (Level 1 inputs). For OTC options or exchange traded options where a quoted price in an active market is not available, fair values are derived based upon observable inputs (Level 2 inputs) such as multiple market maker quotes, which are considered to be binding.
 
The Company purchases and sells CDS for the purposes of either managing its exposure to certain investments, or for other strategic investment purposes. A CDS is a derivative instrument that provides protection against an investment loss due to specified credit or default events of a reference entity. The seller of a CDS guarantees to pay the buyer a specified amount if the reference entity defaults on its obligations or fails to perform. The buyer of a CDS pays a premium over time to the seller in exchange for obtaining this protection. A CDS trading in an active market is valued at fair value based on broker or market maker quotes for identical instruments in an active market (Level 2) or based on the current credit spreads on identical contracts (Level 2).




10


Comprehensive Income (Loss)

The Company has no other comprehensive income (loss), other than the net income (loss) disclosed in the condensed consolidated statements of income.

Earnings (Loss) Per Share
 
Basic earnings (loss) per share are based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings (loss) per share include the dilutive effect of additional potential common shares issuable when stock options are exercised and are determined using the treasury stock method. U.S. GAAP requires that unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (referred to as ‘‘participating securities”), be included in the number of shares outstanding for both basic and diluted earnings per share calculations. The Company treats its unvested restricted stock as participating securities. In the event of a net loss, all stock options outstanding and all participating securities are excluded from the calculation of both basic and diluted loss per share since their inclusion would be anti-dilutive.
 
Three months ended
 June 30,

Six months ended
 June 30,
 
2012

2011
 
2012

2011
Weighted average shares outstanding - basic
36,660,267

 
36,153,743

 
36,605,610

 
36,153,743

Effect of dilutive service provider share-based awards

 

 
148,971

 

Effect of dilutive employee and director share-based awards

 

 
583,903

 

Weighted average share outstanding - diluted
36,660,267

 
36,153,743

 
37,338,484

 
36,153,743

Anti-dilutive stock options outstanding
180,000

 
240,000

 
180,000

 
240,000

Participating securities excluded from calculation of loss per share 
307,931

 
422,073

 

 
422,073


Taxation
 
Under current Cayman Islands law, no corporate entity, including the Company, is obligated to pay taxes in the Cayman Islands on either income or capital gains. The Company has an undertaking from the Governor-in-Cabinet of the Cayman Islands, pursuant to the provisions of the Tax Concessions Law, as amended, that, in the event that the Cayman Islands enacts any legislation that imposes tax on profits, income, gains or appreciations, or any tax in the nature of estate duty or inheritance tax, such tax will not be applicable to the Company or its operations, or to the Class A or Class B ordinary shares or related obligations, until February 1, 2025.
 
Verdant is incorporated in Delaware, and therefore, is subject to taxes in accordance with the U.S. federal rates and regulations prescribed by the U.S. Internal Revenue Service. Verdant’s taxable income is generally expected to be taxed at a rate of 35%.

GRIL is incorporated in Ireland and therefore is subject to the Irish corporation tax rate of 12.5% on its trading income, and 25% on its non-trading income, if any.

Any deferred tax asset is evaluated for recovery and a valuation allowance is recorded when it is more likely than not that the deferred tax asset will not be realized in the future. The Company has not taken any income tax positions that are subject to significant uncertainty or that are reasonably likely to have a material impact on the Company.
 
Recently Adopted Accounting Standards
 
In May 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update No. 2011-04 ("ASU 2011-04"), Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards ("IFRS"). ASU 2011-04 explains how to measure fair value, but does not require additional fair value measurements and is not intended to establish valuation standards. ASU 2011-04 became effective for the Company during the three months ended March 31, 2012. The adoption of ASU 2011-04 did not have a material impact on the Company's results of operations, financial position or disclosures.

In October 2010, the FASB issued Accounting Standards Update No. 2010-26 (“ASU 2010-26”), Financial Services –

11


Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. ASU 2010-26 modifies the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. ASU 2010-26 became effective for the Company during the three months ended March 31, 2012 and was applied prospectively upon adoption. The adoption of ASU 2010-26 did not have a material impact on the Company’s results of operations or financial position.  

Reclassifications
Certain prior period balances have been reclassified to conform to the current period presentation. The reclassifications resulted in no changes to net income (loss) or retained earnings for any of the periods presented.

3.         FINANCIAL INSTRUMENTS 
 
In the normal course of its business, the Company purchases and sells various financial instruments which include listed and unlisted equities, corporate and sovereign debt, commodities, futures, put and call options, currency forwards, other derivatives and similar instruments sold, not yet purchased.

   Fair Value Hierarchy

The Company’s financial instruments are carried at fair value, and the net unrealized gains or losses are included in net investment income in the condensed consolidated statements of income.
 
The following table presents the Company’s investments, categorized by the level of the fair value hierarchy as of June 30, 2012:
 
 
Fair Value Measurements as of June 30, 2012
 
 
Description
 
Quoted prices in
active markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets: 
 
($ in thousands)
Debt instruments
 
$

 
$
8,745

 
$
343

 
$
9,088

Listed equity securities
 
1,057,800

 
929

 

 
1,058,729

Commodities
 
99,708

 

 

 
99,708

Private and unlisted equity securities
 

 

 
38,805

 
38,805

Financial contracts receivable
 
3,688

 
20,270

 
14

 
23,972

 
 
$
1,161,196

 
$
29,944

 
$
39,162

 
$
1,230,302

Liabilities:
 
 
 
 
 
 
 
 
Listed equity securities, sold not yet purchased
 
$
(556,993
)
 
$

 
$

 
$
(556,993
)
Debt instruments, sold not yet purchased
 

 
(106,549
)
 

 
(106,549
)
Financial contracts payable
 
(952
)
 
(12,020
)
 

 
(12,972
)

 
$
(557,945
)
 
$
(118,569
)
 
$

 
$
(676,514
)
 













12



The following table presents the Company’s investments, categorized by the level of the fair value hierarchy as of December 31, 2011:

 
Fair Value Measurements as of December 31, 2011
 
 
Description
 
Quoted prices in
active markets
(Level 1)
 
Significant other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets: 
 
($ in thousands)
Debt instruments
 
$

 
$
10,174

 
$
465

 
$
10,639

Listed equity securities
 
866,069

 
24,753

 

 
890,822

Commodities
 
97,506

 

 

 
97,506

Private and unlisted equity securities
 

 

 
31,179

 
31,179

Financial contracts receivable
 
881

 
22,529

 
263

 
23,673

 
 
$
964,456

 
$
57,456

 
$
31,907

 
$
1,053,819

Liabilities:
 
 
 
 
 
 
 
 
Listed equity securities, sold not yet purchased
 
$
(539,197
)
 
$

 
$

 
$
(539,197
)
Debt instruments, sold not yet purchased
 

 
(144,619
)
 

 
(144,619
)
Financial contracts payable
 
(1,070
)
 
(5,254
)
 

 
(6,324
)

 
$
(540,267
)
 
$
(149,873
)
 
$

 
$
(690,140
)
 
The following table presents the reconciliation of the balances for all investments measured at fair value using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2012

 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Three months ended June 30, 2012
 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Six months ended June 30, 2012

 
Debt instruments
 
 Private and unlisted equity securities
 
 Financial contracts receivable
 
 Total
 
Debt instruments
 
 Private and unlisted equity securities
 
Financial contracts receivable
 
 Total

 
 ($ in thousands)
 
 ($ in thousands)
Beginning balance
 
$
418

 
$
35,758

 
$
125

 
$
36,301

 
$
465

 
$
31,178

 
$
263

 
$
31,906

Purchases
 

 
3,541

 

 
3,541

 

 
6,912

 

 
6,912

Sales
 

 
(306
)
 

 
(306
)
 
(1
)
 
(492
)
 

 
(493
)
Issuances
 

 

 

 

 

 

 

 

Settlements

 

 

 

 

 

 

 

Total realized and unrealized gains (losses) and amortization included in earnings, net
 
(75
)
 
960

 
(111
)
 
774

 
(121
)
 
2,355

 
(249
)
 
1,985

Transfers into Level 3
 

 

 

 

 

 

 

 

Transfers out of Level 3
 

 
(1,148
)
 

 
(1,148
)
 

 
(1,148
)
 

 
(1,148
)
Ending balance
 
$
343

 
$
38,805

 
$
14

 
$
39,162

 
$
343

 
$
38,805

 
$
14

 
$
39,162





13





The following table presents the reconciliation of the balances for all investments measured at fair value using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2011:


 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Three months ended June 30, 2011
 
  Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Six months ended June 30, 2011

 
Debt instruments
 
 Private and unlisted equity securities
 
 Total
 
Debt instruments
 
 Private and unlisted equity securities
 
Financial contracts receivable
 
 Total

 
 ($ in thousands)
 
 ($ in thousands)
Beginning balance
 
$
838

 
$
37,601

 
$
38,439

 
$
3,245

 
$
42,947

 
$
214

 
$
46,406

Purchases
 

 
1,914

 
1,914

 

 
4,599

 

 
4,599

Sales
 
(4
)
 
(417
)
 
(421
)
 
(2,401
)
 
(1,365
)
 

 
(3,766
)
Issuances
 

 

 

 

 

 

 

Settlements
 

 

 

 

 

 

 

Total realized and unrealized gains (losses) and amortization included in earnings, net
 
(41
)
 
813

 
772

 
(51
)
 
3,392

 
(214
)
 
3,127

Transfers into Level 3
 

 

 

 

 

 

 

Transfers out of Level 3
 

 

 

 

 
(9,662
)
 

 
(9,662
)
Ending balance
 
$
793

 
$
39,911

 
$
40,704

 
$
793

 
$
39,911

 
$

 
$
40,704


During the three and six months ended June 30, 2012, $1.1 million of securities, at fair value based on the date of transfer, were transferred from Level 3 to Level 2, as these securities started actively trading on a listed exchange during the second quarter of 2012. However, due to lock-up period restrictions on these securities, a liquidity discount was used in determining their fair value at June 30, 2012, and therefore classified as Level 2.

Additionally, during the three and six months ended June 30, 2012, $29.4 million of securities, at fair value based on the date of transfer, were transferred from Level 2 to Level 1 as the lock-up period on those securities expired. There were no other transfers between Level 1, Level 2 or Level 3 during the three and six months ended June 30, 2012.

During the six months ended June 30, 2011, $9.7 million of securities, at fair value based on the date of transfer, were transferred from Level 3 to Level 1, as these securities started actively trading on listed exchanges during the first quarter of 2011. There were no other transfers between Level 1, Level 2 or Level 3 during the three and six months ended June 30, 2011.

For the three and six months ended June 30, 2012, realized gains of $0.1 million and $0.2 million, respectively, (2011: $0 and $0, respectively) and change in unrealized gains of $0.8 million and $2.0 million (2011: $0.8 million and $3.3 million) on securities held at the reporting date and valued using unobservable inputs are included in net investment income in the condensed consolidated statements of income.  In addition, for the three and six months ended June 30, 2012, amortization expense of $0.1 million and $0.2 million (2011: $0 and $0.2 million) relating to financial contracts receivable valued using unobservable inputs, was included in other income (expense), net. 
 
Investments
 
Debt instruments, trading
 
At June 30, 2012, the following investments were included in debt instruments:

14


2012
 
Cost/
 amortized
 cost
 
Unrealized
 gains
 
Unrealized
 losses
 
Fair
 value
 
 
($ in thousands)
Corporate debt – U.S.
 
$
5,036

 
$
120

 
$
(1,904
)
 
$
3,252

Corporate debt – Non U.S.
 
3,031

 
587

 
(59
)
 
3,559

Sovereign debt – Non U.S.
 
$
2,113

 
$
164

 
$

 
2,277

Total debt instruments
 
$
10,180

 
$
871

 
$
(1,963
)
 
$
9,088

 
At December 31, 2011, the following investments were included in debt instruments:
2011
 
Cost/
 amortized
 cost
 
Unrealized
 gains
 
Unrealized
 losses
 
Fair
 value
 
 
($ in thousands)
Corporate debt – U.S.
 
$
4,064

 
$
49

 
$
(1,685
)
 
$
2,428

Corporate debt – Non U.S.
 
5,010

 
435

 

 
5,445

Sovereign debt – Non U.S.
 
2,481

 
285

 

 
2,766

Total debt instruments
 
$
11,555

 
$
769

 
$
(1,685
)
 
$
10,639


The maturity distribution for debt instruments held at June 30, 2012 was as follows:
 
 
Cost/
 amortized
 cost
 
Fair
 value

 
($ in thousands)
Within one year
 
$

 
$

From one to five years
 
548

 
691

From five to ten years
 
6,136

 
6,806

More than ten years
 
3,496

 
1,591


 
$
10,180

 
$
9,088

 
Investment in Equity Securities, Trading

At June 30, 2012, the following long positions were included in investment securities, trading: 
2012

Cost

Unrealized
gains

Unrealized
losses

Fair
value
 

($ in thousands)
Equities – listed

$
972,732


$
139,600


$
(90,420
)

$
1,021,912

Exchange traded funds

38,818




(2,001
)

36,817

 
 
$
1,011,550

 
$
139,600

 
$
(92,421
)
 
$
1,058,729


At December 31, 2011, the following long positions were included in investment securities, trading:
2011

Cost

Unrealized
gains

Unrealized
losses

Fair
value
 

($ in thousands)
Equities – listed

$
827,435


$
78,947


$
(75,593
)

$
830,789

Exchange traded funds

57,011


6,037


(3,015
)

60,033

 
 
$
884,446

 
$
84,984

 
$
(78,608
)
 
$
890,822




15


Other Investments
 
“Other investments” include commodities and private and unlisted equity securities. As of June 30, 2012 and December 31, 2011, commodities were comprised of gold bullion. 

At June 30, 2012, the following securities were included in other investments:
2012

Cost

Unrealized
gains

Unrealized
losses

Fair
value
 

($ in thousands)
Commodities

$
65,365


$
34,343


$


$
99,708

Private and unlisted equity securities

37,642


3,193


(2,030
)

38,805

 

$
103,007

 
$
37,536

 
$
(2,030
)
 
$
138,513


At December 31, 2011, the following securities were included in other investments: 
2011

Cost

Unrealized
gains

Unrealized
losses

Fair
value
 

($ in thousands)
Commodities

$
65,365


$
32,141


$


$
97,506

Private and unlisted equity securities

32,157


2,146


(3,124
)

31,179

 

$
97,522

 
$
34,287

 
$
(3,124
)
 
$
128,685

 
As of June 30, 2012, included in private and unlisted equity securities are investments in private equity funds with a fair value of $19.3 million (December 31, 2011: $12.8 million) determined based on unadjusted net asset values reported by the funds' managers as of periods prior to June 30, 2012. The private equity funds have varying lock-up periods and as of June 30, 2012 one hundred percent of the funds were not redeemable due to restrictions, and therefore have been categorized within Level 3 of the fair value hierarchy. As of June 30, 2012, the Company had $12.1 million (December 31, 2011: $18.4 million) of unfunded commitments relating to private equity funds whose fair values are determined based on unadjusted net asset values reported by the funds' managers. These commitments are included in the amounts presented in the schedule of commitments and contingencies in Note 8 of these condensed consolidated financial statements.    

Investments in Securities Sold, Not Yet Purchased 

At June 30, 2012, the following securities were included in investments in securities sold, not yet purchased:
2012
 
Proceeds
 
Unrealized gains
 
Unrealized losses
 
 Fair value
 
 
($ in thousands)
Equities – listed
 
$
(634,172
)
 
$
139,564

 
$
(62,385
)
 
$
(556,993
)
Corporate debt – U.S
 
(1,870
)
 
72

 

 
(1,798
)
Sovereign debt – Non U.S
 
(112,620
)
 
7,869

 

 
(104,751
)
 
 
$
(748,662
)
 
$
147,505

 
$
(62,385
)
 
$
(663,542
)

At December 31, 2011, the following securities were included in investments in securities sold, not yet purchased: 
2011
 
Proceeds
 
Unrealized gains
 
Unrealized losses
 
 Fair value
 
 
($ in thousands)
Equities – listed
 
$
(583,078
)
 
$
98,726

 
$
(54,845
)
 
$
(539,197
)
Corporate debt – U.S
 
(1,870
)
 
11

 

 
(1,859
)
Sovereign debt – Non U.S
 
(153,828
)
 
11,068

 

 
(142,760
)
 
 
$
(738,776
)
 
$
109,805

 
$
(54,845
)
 
$
(683,816
)
 

16


Financial Contracts
 
As of June 30, 2012 and December 31, 2011, the Company had entered into total return swaps, CDS, options, futures and interest rate options contracts with various financial institutions to meet certain investment objectives. Under the terms of each of these financial contracts, the Company is either entitled to receive or is obligated to make payments which are based on the product of a formula contained within the contract that includes the change in the fair value of the underlying or reference security. In addition, as of June 30, 2012 and December 31, 2011, the Company had entered into a non-exchange traded weather derivative swap contract to manage its overall risk exposure to earthquake losses, under which the Company is entitled to receive a payment upon the occurrence of certain specified earthquake events in the U.S. 
 
At June 30, 2012, the fair values of financial contracts outstanding were as follows: 
Financial Contracts
 
Listing
currency
 
Notional amount of
underlying instruments
 
Fair value of net assets
(obligations)
on financial
contracts
 
 
 
 
($ in thousands)
Financial contracts receivable
 
 
 
 
 
 
Interest rate options
 
USD
 
2,638,753

 
$
633

Credit default swaps, purchased – corporate debt
 
USD
 
39,665

 
815

Total return swaps – equities
 
USD
 
22,127

 
4,981

Put options
 
USD
 
193,767

 
11,243

Call options
 
USD
 
46,740

 
2,597

Futures
 
USD
 
134,827

 
3,689

Weather derivative swap
 
USD
 
5,000

 
14

Total financial contracts receivable, at fair value
 
 
 
 
 
$
23,972

Financial contracts payable
 
 
 
 
 
 
Credit default swaps, purchased – sovereign debt
 
USD
 
251,467

 
$
(5,587
)
Credit default swaps, purchased – corporate debt
 
USD
 
234,212

 
(2,101
)
Futures
 
USD
 
165,530

 
(878
)
Total return swaps – equities
 
USD
 
22,450

 
(4,326
)
Warrants and rights on listed equities
 
USD
 
73

 
(73
)
Call options
 
USD
 
103

 
(7
)
Total financial contracts payable, at fair value
 
 
 
 
 
$
(12,972
)
 




















17


At December 31, 2011, the fair values of financial contracts outstanding were as follows: 
Financial Contracts
 
Listing
currency
 
Notional amount of
underlying instruments
 
Fair value of net assets
(obligations)
on financial
contracts
 
 
 
 
($ in thousands)
Financial contracts receivable
 
 
 
 
 
 
Interest rate options
 
USD
 
3,049,338

 
$
2,236

Credit default swaps, purchased – sovereign debt
 
USD
 
32,952

 
6,160

Credit default swaps, purchased – corporate debt
 
USD
 
260,862

 
1,614

Total return swaps - equities
 
USD
 
45,458

 
5,390

Put options
 
USD
 
132,966

 
6,849

Call options
 
USD
 
2,714

 
280

Futures
 
USD
 
9,075

 
881

Weather derivative swap
 
USD
 
5,000

 
263

Total financial contracts receivable, at fair value
 
 
 
 
 
$
23,673

Financial contracts payable
 
 
 
 

 
 

Credit default swaps, purchased – sovereign debt
 
USD
 
251,467

 
$
(2,675
)
Credit default swaps, purchased – corporate debt
 
USD
 
26,029

 
(799
)
Futures
 
USD
 
149,201

 
(887
)
Total return swaps – equities
 
USD
 
11,795

 
(1,714
)
Warrants and rights on listed equities
 
USD
 
183

 
(183
)
Call options
 
USD
 
718

 
(66
)
Total financial contracts payable, at fair value
 
 
 
 
 
$
(6,324
)
 
As of June 30, 2012 and December 31, 2011, included in interest rate options are contracts on U.S. and Japanese interest rates. Included in put options are options on foreign currencies including the Japanese Yen and Euro.  

As of June 30, 2012 and December 31, 2011, the carrying amount of the weather derivative swap is the unamortized portion of the premium paid to purchase the weather derivative swap contract which expired on July 10, 2012. An estimate of fair value is not practicable since the weather derivative swap contract is a non-exchange traded instrument and the time and cost involved in creating a valuation model to estimate the fair value would be excessive based on the immaterial amount and the short term contract period.





















18


During the three and six months ended June 30, 2012 and 2011, the Company reported gains and losses on derivatives as follows:
Derivatives not designated as hedging instruments
 
Location of gains and losses on derivatives recognized in income
 
Gain (loss) on derivatives recognized
in income for the three months ended
June 30,
 
Gain (loss) on derivatives recognized
in income for the six months ended
June 30,
 
 
 
 
2012
 
2011
 
2012
 
2011
 
 
 
 
($ in thousands)
 
($ in thousands)
Interest rate options
 
Net investment income (loss)
 
$
(1,251
)
 
$
(5,518
)
 
$
(1,603
)
 
$
(4,554
)
Credit default swaps, purchased – corporate debt
 
Net investment income (loss)
 
(185
)
 
(632
)
 
(4,000
)
 
(1,976
)
Credit default swaps, purchased – sovereign debt
 
Net investment income (loss)
 
1,027

 
1,461

 
(3,944
)
 
(7,219
)
Total return swaps – equities
 
Net investment income (loss)
 
(1,772
)
 
29

 
(2,482
)
 
3,317

Credit default swaps, issued – corporate debt
 
Net investment income (loss)
 

 
(3
)
 

 
4,785

Options, warrants, and rights
 
Net investment income (loss)
 
(14,981
)
 
(8,908
)
 
(10,167
)
 
(20,325
)
Futures
 
Net investment income (loss)
 
(3,176
)
 

 
(7,959
)
 

Currency forwards
 
Net investment income (loss)
 

 
(3,944
)
 

 
(3,944
)
Weather derivative swap
 
Other income (expense), net
 
(111
)
 

 
(249
)
 
(214
)
Total
 
 
 
$
(20,449
)
 
$
(17,515
)
 
$
(30,404
)
 
$
(30,130
)

The Company generally does not enter into derivatives for risk management or hedging purposes, and the volume of derivative activities varies from period to period depending on potential investment opportunities.

For the three and six months ended June 30, 2012, the Company’s volume of derivative activities (based on notional amounts) was as follows:
 
 
Three months ended June 30, 2012
 
Six months ended June 30, 2012
Derivatives not designated as hedging instruments
 
  Entered
 
Exited
 
  Entered
 
Exited
 
 
($ in thousands)
 
($ in thousands)
Credit default swaps
 
$

 
$
43,014

 
$

 
$
45,966

Total return swaps
 
728

 
6,625

 
2,806

 
20,554

Options
 
169,304

 
59,119

 
444,207

 
202,704

Futures
 
301,197

 
336,611

 
764,267

 
629,556

Total
 
$
471,229

 
$
445,369

 
$
1,211,280

 
$
898,780












19


For the three and six months ended June 30, 2011, the Company’s volume of derivative activities (based on notional amounts) was as follows:
 
 
Three months ended June 30, 2011
 
Six months ended June 30, 2011
Derivatives not designated as hedging instruments
 
  Entered
 
Exited
 
  Entered
 
Exited
 
 
($ in thousands)
 
($ in thousands)
Credit default swaps
 
$
204,053

 
$
91,632

 
$
213,942

 
$
137,749

Total return swaps
 
11,203

 
1,655

 
11,203

 
16,603

Options
 
247,964

 
184,067

 
546,988

 
230,490

Futures
 
12,469

 

 
41,726

 
55,093

Currency Forwards
 
372,843

 
262,622

 
372,843

 
262,622

Weather derivative swap
 

 

 

 
10,000

Total
 
$
848,532

 
$
539,976

 
$
1,186,702

 
$
712,557


4.        DUE TO PRIME BROKERS
 
As of June 30, 2012, the amount due to prime brokers is comprised of margin-borrowing from prime brokers relating to investments purchased on margin as well as the margin-borrowing for providing collateral to support some of the Company’s outstanding letters of credit (see Note 8). Under term margin agreements and certain letter of credit facility agreements, the Company pledges certain investment securities to borrow cash from the prime brokers. The borrowed cash is placed in a custodial account in the name of the Company and this custodial account provides collateral for any letters of credit issued by the banks. Since there is no legal right of offset, the Company’s liability for the cash borrowed from the prime brokers is included on the condensed consolidated balance sheets as due to prime brokers while the cash held in the custodial account is included on the condensed consolidated balance sheets as restricted cash and cash equivalents. At June 30, 2012, the amounts due to prime brokers included $238.1 million (December 31, 2011: $256.1 million) of cash borrowed under the term margin agreements to provide collateral for letters of credit facilities and $126.9 million (December 31, 2011: $4.3 million) of borrowing relating to investment purchases.

The Company's investment guidelines allow for temporary (30 days) leverage for investment purposes up to 20% of net invested assets, and for an extended time period, up to 5% of net invested assets. At June 30, 2012 and December 31, 2011, the Company was in compliance with the amount of leverage for investment purposes allowed under its investment guidelines.

5.        RETROCESSION
 
The Company from time to time purchases retrocessional coverage for one or more of the following reasons: to manage its overall exposure, to reduce its net liability on individual risks, to obtain additional underwriting capacity and to balance its underwriting portfolio. Additionally, retrocession can be used as a mechanism to share the risks and rewards of business written and therefore can be used as a tool to align the Company's interests with those of its counterparties. The Company currently has coverages that provide for recovery of a portion of loss and loss expenses incurred on certain contracts. Loss and loss adjustment expense recoverable from the retrocessionaires are recorded as assets. For the three months ended June 30, 2012, loss and loss adjustment expenses incurred of $87.3 million (2011: $56.9 million) reported on the condensed consolidated statements of income are net of loss and loss expenses recovered and recoverable of $6.9 million (2011: $3.9 million). For the six months ended June 30, 2012, loss and loss adjustment expenses incurred of $150.6 million (2011: $122.6 million) reported on the condensed consolidated statements of income are net of loss and loss expenses recovered and recoverable of $16.2 million (2011: $7.8 million). Retrocession contracts do not relieve the Company from its obligations to the insureds. Failure of retrocessionaires to honor their obligations could result in losses to the Company. At June 30, 2012, the Company had loss and loss adjustment expense recoverable of $0.1 million (December 31, 2011: $0.1 million) with a retrocessionaire rated “A+ (Superior)” by A.M. Best. Additionally, the Company had losses recoverable of $36.8 million (December 31, 2011: $29.7 million) with unrated retrocessionaires. At June 30, 2012 and December 31, 2011, the Company retained $34.7 million and $38.0 million, respectively, of cash collateral from the unrated retrocessionaires, as well as other collateral in the form of guarantees. The Company regularly evaluates the financial condition of its retrocessionaires to assess the ability of the retrocessionaires to honor their obligations. At June 30, 2012 and December 31, 2011, no provision for uncollectible losses recoverable was considered necessary.
 

20


6.        SHARE-BASED COMPENSATION
 
The Company has a stock incentive plan for directors, employees and consultants. As of June 30, 2012, the Company had reserved for issuance 3,500,000 Class A ordinary shares (December 31, 2011: 3,500,000) for eligible participants. At June 30, 2012, 1,182,269 Class A ordinary shares (December 31, 2011: 1,322,773) were available for future issuance under the Company’s stock incentive plan.
 
Employee and Director Restricted Shares
 
As part of the stock incentive plan, the Company issues restricted shares for which the fair value is equal to the price of the Company’s Class A ordinary shares on the grant date. Compensation based on the grant date fair market value of the shares is expensed on a straight line basis over the vesting period.
 
During the six months ended June 30, 2012, 110,701 (2011: 86,737) restricted Class A ordinary shares were issued to employees pursuant to the Company’s stock incentive plan. These shares contain certain restrictions relating to, among other things, vesting, forfeiture in the event of termination of employment and transferability. Each of these restricted shares will cliff vest after 3 years from the date of issue, subject to the grantee’s continued service with the Company.
  
During the six months ended June 30, 2012, the Company also issued to non-employee directors an aggregate of 35,994 (2011: 33,295) restricted Class A ordinary shares as part of their remuneration for services to the Company. Each of these restricted shares issued to the directors contain similar restrictions to those issued to employees and will vest on the earlier of the first anniversary of the share issuance or the Company’s next annual general meeting, subject to the grantee’s continued service with the Company.

The restricted share award activity during the six months ended June 30, 2012 was as follows:
 
Number of
non-vested
restricted
 shares
 
Weighted
 average
grant date
fair value
Balance at December 31, 2011
358,563

 
$
21.03

Granted
146,695

 
24.61

Vested
(191,136
)
 
17.34

Forfeited
(6,191
)
 
25.44

Balance at June 30, 2012
307,931

 
$
24.94

 
Employee and Director Stock Options
 
Employee and director stock option activity during the six months ended June 30, 2012 was as follows: 
 
Number of
 options
 
Weighted
 average
 exercise
 price
 
Weighted
 average
 grant date
 fair value
Balance at December 31, 2011
1,399,000

 
$
15.06

 
$
6.73

Granted

 

 

Exercised

 

 

Forfeited

 

 

Expired

 

 

Balance at June 30, 2012
1,399,000

 
$
15.06

 
$
6.73

 

7.      RELATED PARTY TRANSACTIONS 
 
Investment Advisory Agreement
 

21


The Company and its reinsurance subsidiaries are party to an Investment Advisory Agreement (the ‘‘Advisory Agreement’’) with DME Advisors under which the Company, its reinsurance subsidiaries and DME Advisors created a joint venture for the purpose of managing certain jointly held assets. DME Advisors is a related party and an affiliate of David Einhorn, Chairman of the Company’s Board of Directors.  
 
Pursuant to the Advisory Agreement, performance compensation equal to 20% of the net income of the Company’s share of the account managed by DME Advisors is allocated, subject to a loss carry forward provision, to DME Advisors’ account. The loss carry forward provision allows DME Advisors to earn reduced incentive compensation of 10% on net investment income in any year subsequent to the year in which the investment account incurs a loss, until all the losses are recouped and an additional amount equal to 150% of the aggregate investment loss is earned. DME Advisors is not entitled to earn performance compensation in a year in which the investment portfolio incurs a loss. For the three and six months ended June 30, 2012, included in net investment income is performance compensation of $(9.1) million and $7.9 million, respectively, (2011: $0.0 million and $0.0 million, respectively) that was accrued and included in the condensed consolidated balance sheets at June 30, 2012 as performance compensation payable to related party. The negative performance compensation for the three months ended June 30, 2012 was due to a net investment loss during the period resulting in partial reversal of performance compensation previously accrued based on the investment returns during the first quarter of 2012.
 
Additionally, pursuant to the Advisory Agreement, a monthly management fee equal to 0.125% (1.5% on an annual basis) of the Company’s investment account managed by DME Advisors is paid to DME Advisors. Included in the net investment income for the three and six months ended June 30, 2012 are management fees of $4.2 million and $8.3 million, respectively (2011: $3.8 million and $7.6 million, respectively). The management fees have been fully paid as of June 30, 2012.
 
Pursuant to the Advisory Agreement, the Company has agreed to indemnify DME Advisors for any expense, loss, liability, or damage arising out of any claim asserted or threatened in connection with DME Advisors serving as the Company’s investment advisor. The Company will reimburse DME Advisors for reasonable costs and expenses of investigating and/or defending such claims provided such claims were not caused due to gross negligence, breach of contract or misrepresentation by DME Advisors. During the six months ended June 30, 2012, there were no indemnification payments made by the Company.
 
Service Agreement
 
The Company has entered into a service agreement with DME Advisors, pursuant to which DME Advisors provides investor relations services to the Company for compensation of $5,000 per month (plus expenses). The agreement is automatically renewed annually until terminated by either the Company or DME Advisors for any reason with 30 days prior written notice to the other party. 

8.      COMMITMENTS AND CONTINGENCIES 
 
Letters of Credit
 
At June 30, 2012, the Company had the following letter of credit facilities, which automatically renew each year unless terminated by either party in accordance with the required notice period:

 
Facility
 
Termination Date
 
Notice period required for termination
 
 
($ in thousands)
 
 
 
 
Bank of America, N.A
 
$
200,000

 
July 20, 2013
 
90 days prior to termination date
Butterfield Bank (Cayman) Limited
 
60,000

 
June 30, 2013
 
90 days prior to termination date
Citibank Europe plc
 
400,000

 
October 11, 2013
 
120 days prior to termination date