Old Republic International Corp (ORI) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Old Republic International third quarter 2010 earnings conference call. Today's call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue for questions. I would like to remind everyone that this conference is being recorded, and would now like to turn the conference over to Leslie Loyet of the Financial Relations Board. Please go ahead.

Thank you and good afternoon. Thank you for joining us for the Old Republic conference call to discuss third quarter 2010 results. This morning we distributed a copy of the press release and hopefully you've all had a chance to review the results. If there is anyone online that did not receive a copy, you can access it at the Old Republic's website at www.OldRepublic. com, or you can call Liz [Dolezal] at 312-640-6771 and she can send you a copy immediately. Please be advised that this call may involve forward-looking statements as discussed in the press release dated October 28th, 2010. Risks associated with these statements can be found in the Company's latest SEC filings. Joining us today from management are Al Zucaro, Chairman and Chief Executive Officer, and Chris Nard, President. That time I would like to turn the call over to Al Zucaro for opening remarks. Please go ahead.

Thank you you. Good afternoon everybody and thank you once again for joining us on this call. As we've done in the recent past, Chris Nard and I will share the microphone and shed a little more light on this morning's earnings release. After that, as Leslie just mentioned, we'll address any questions that you have. I might note that at the outset that while we've expanded the statistical supplement to the earnings release, we have posted it now on the Old Republic website if you want to refer to it.

Consolidated wise, there is no hiding the fact that we experienced somewhat unanticipated and relatively poor underwriting results in the latest quarter. On the other hand, as you can see readily, the nine month results still look vastly superior to those we posted in the same nine months of last year. As you can see in the summary table on page two of the release, the earnings difficulties flow primarily from our General and Mortgage Guaranty lines. In General Insurance, the substantial increase in this year's underwriting ratios stems from just one of the coverages we underwrite, namely the Consumer Credit Indemnity, or as we refer to it, CCI product for short. The immediate cause of this spike in CCI lost costs arises from a claim validation catch-up on our largest account.

As we reported, I believe for a couple of quarters now, this catch-up process is resulting in a quicker resolution of claims subject to validation. Or as we like to say in the property and casualty business, subject to the procurement of a proof of loss. And it's also causing a faster posting of necessary reserves and payments of claims. To get a sense of the effect that this is having on our general insurance claim ratio and the trends on it for the past several quarters, if you look at 2008, the CCI costs -- claim costs increased or added 6.1 percentage points to the loss ratio for that year. In 2009 the increase was 7.3 percentage points. And for the first nine months of this year, it was 9.6 percentage points as we point out in the release.

I might just say that as we speak there are fewer delinquencies being reported on CCI, and the number of claims pending verification prior to payment is also trending down. But we still need a couple of quarters to see whether this trend continues before we conclude that the worst is over from this standpoint.

Apart from the CCI situation, which incidentally involves a quick declining premium base, since we're not writing any new business in this cycle, the rest of our General Insurance book of business is performing and continues to perform very well. You can see this on the second page of the statistical supplement that I mentioned before, being -- that's posted on our website. And if you have it handy, you can see on that page that there is a great deal of stability in lost costs. Sure enough, individual lines bounce around a little bit from quarter to quarter, but, in totality, particularly with respect to our largest segments of liability insurance, which together represent some two-thirds of our General Insurance business, there is, as I say, quite a bit of stability there. By the same token, there is also quite a bit of steadiness in the ever-so-slight down trend in the premium line.

And as we've reported for a couple of three years now, the combination of a fairly consistent drop in premium rates for most of the coverages we write, as well as the current economic downturn, the combination of those items are truly the root causes for this situation. Our present view, incidentally, is that premium rates are no longer falling to any significant degree, at least for the parts of the property and casualty business that we work with. But any pick-up in the top line will have to wait. A resumption of stronger economic activity; and that's what is going to move that top line. And unfortunately, at least, we are of the belief that this improvement in the American economy is going to take place over a very slow track over the next several years. In our case, again from a topline standpoint, however, the merger which just took place on October 1st with the PMA companies will certainly add to our consolidated top line, beginning in the fourth quarter of this year. And we also expect that this merger, that the results of PMA, will provide something of a boost to bottom line as well.

In terms of General Insurance, earnings quality, the all-important loss reserves for prior years continued to develop favorably so far this year. But the level of redundancy, which typically for us amounts to 2% to 3%, that level has been clipped to some degree this year by adverse development on the CCI claims for the reasons that we've already cited.

Operating cash flow in this business remains very positive. Though it is trending down, as you might expect, and that's due to, again, the topline issues that we're having to deal with, as well as the faster claim payments that we've already noted again. Having said that, I'll turn it over to Chris.

Thank you. Excuse me. As you can see in the release, the MI results in this year's third quarter deteriorated somewhat from what we saw in the same period last year. Although I'm pleased to see that year-to-date comparisons showed significant improvement. In both instances, if you leave aside the effects of the captive commutations and the pool terminations, which we've outlined on page four, the year-over-year changes for the most part driven by varying changes in the claim payment trends, and then changes in some of the reserve provisions.

On the delinquency side, traditional primary delinquencies were down 5.1% in the third quarter. When compared to the third quarter in '09. And then in the quarter-to-quarter comparison, traditional primary delinquents were down 6.4%. This decline in the delinquent inventory, really throughout of 2010, has been reflective of a decline in the newly reported delinquents which we have talked about for several quarters now. A improvement in the cure rates that we've seen in 2012 -- or 2010, in addition to the influence that the increased level of paid activities has had in the delinquent population as well.

With respect to the production side of the business, new insurance written was down in the third quarter and in the year-to-date comparisons. But on a positive note, the new insurance written continues to trend up for the year and was up 14% in comparison to the second quarter of 2010. Net-earn premium line continues to slide, continuing as a result of several factors in the business. One is obviously the low levels of new insurance written that we've seen over the years. Two, the continued run-off of the bulk business. And that recently has been accelerated by the termination of several of these pool contracts we've talked about in the past. And lastly, the high level of refunded premiums related to the elevated level of claim recisions we're seeing.

Also net risk in force has continued to decline. This is largely driven by the fact that the low levels of new insurance written that we just discussed are unable to make up for the risks that left the book due to refinancings or claim settlements in the period. We would continue to expect that risk in force number will be challenged through the rest of this year, and really into 2011, as we would anticipate these trends to continue.

While the first three quarters of 2010 indicate some improving trends in the term of MI industry volume, for the year private mortgage insurance industry volumes are down significantly. And the MI penetration rate continues to run at less than 5%, which is down significantly from the recent peak in early 2008 of around 14.5%. Year-to-date on a market share side, the company's market share has trended down somewhat and is running a little bit under 9% for the year-to-date period. One of the primary drivers of this low MI penetration rate has been the growth in the FHA market share, really since the beginning of 2008. And as we've discussed in previous calls, the FHA has started to make several changes that will positively impact it's performance over time. And as of early October, they've significantly raised their monthly premium rates. And we would think in the fourth quarter and into 2011, that change should really improve the MI versus FHA price comparison in several areas, particularly the high credit score areas, and therefore we think that will support an improvement in the long run MI penetration rates as we look at 2011 and '12.

On to the modification side of the business that we've reported on in the past, at the end of August we've seen about 11,000 loans cure as a result of the HAMP program. To date, newly reported HAMPs, though, are obviously down as the bubble of delinquent borrowers -- the big bubble of delinquent borrowers have passed through that program. And the fact that new borrowers who are eligible for a HAMP are provided to require full documentation before entering the process. Those two things will really likely limit the number of new HAMPs that's we see going forward. But on a positive side, in recognition of the need for addition modification opportunities, Fanny and many large servicers have developed modification programs on their own, that work with borrowers who, for one reason or another, may be unable to qualify for a HAMP modification, but could be eligible for another private modification.

As you all know, one of the major news items we've seen in the last few weeks is the reported document issue with foreclosures. And then the ensuing moratoriums that were announced by several large servicers. We would currently anticipate that this would have limited impact on us. Other than extending the time period that loans currently spend in their various delinquency stages, essentially the foreclosure moratorium would have a tendency to freeze the later-stage delinquencies and their various stages. So, it would simply involve an extension of the time that they would be there, and likely not result in any increase in the frequency of default for the effected delinquency.

On to risk-to-capital ratio; you can see from the release, as we've talked about in the last several quarters, that the risk-to-capital ratio for the Mortgage Guaranty Insurance group of companies have surpassed the 25 to 1 level. As we've talked about for the last year or so, we have a waiver from the North Carolina department of insurance, which is the state of domicile for Republic Mortgage Insurance Company, that will permit us to continue to write business when the flagship goes above the 25 to 1 risk-to-capital ratio. And in the event another state, who would have a risk-to-capital requirement, and I think there are about 16 of them, if they have language in their statues that would lead them to be unable to recognize the waiver from the state of North Carolina, or they wouldn't want to grant us a waiver under their existing statutes, we, like the other MIs, have been granted the ability to write under the subsidiary of both Fannie and Freddie. At this point we would anticipate that we would only need to write business in a separate subsidiary in one, maybe two states if the need would arise.

So to summarize where we are in our Mortgage Guaranty business, while we've seen improvements in the delinquency and cure rate trends, and we recognize the potential for increases in the MI penetration rate going forward in 2011, those positives are moderated by what we think are some difficult prospects for employment growth and the excess supply of homes we see in many markets around the country. These two economic conditions will contribute to what we would expect to really continue to be a slow recovery in housing through the end of this year and into the next.

With that, let me take a moment and segue into a report on Old Republic's Title Insurance business. Our Title business continues to build on the positive momentum that they started to gain towards the end of 2009. In the third quarter of this year, we posted a $5.7 million profit -- excuse me -- in comparison to a little over a $4 million profit in the third quarter of last year. And our third quarter results also compare favorably to the second quarter, where we are into, again about a $4 million profit in the second quarter of this year. Premiums and fees earned in our Title business continue to show strong growth, and we're up about 23% over last year's third quarter. And again these gains continue to be largely attributable to our growth in market share, which has resulted from a deal recently; we did a joint venture with the attorney's Title Insurance fund in Florida, and then some market share gains from the various dislocations that we've seen in the Title business over the last year or so.

Company's market share in the second quarter, which is the most recent time period we have available, was about 10.5% versus about 6.8% in the second quarter of 2009. Expense ratio for the third quarter was 91.9%, which was basically flat in comparison to the third quarter of '09 but down just slightly from the previous quarter. And the claim ratio of 8.3% for the quarter, was fundamentally flat in comparison to the third quarter of the 2009.

As I mentioned when I talked about our Mortgage Guaranty business, certainly the event in the real estate industry that garnered the most media attention recently, is the uncovering of these issues related to the foreclosure process, and the ensuing moratoriums on new foreclosures. In our Title business, obviously one big misreported piece of that story, was that Old Republic had stopped providing Title Insurance on foreclosures for two large national lenders. That, in fact, was not the case. But what got picked up was some advice we provided to our Title offices that said, if a foreclosure for one of those two lenders was stopped by the lender, the GSE's or another regulatory body, that our offices, in fact, should stop the processing of that title work. And that release somehow got translated into what you read in the media over the last couple of weeks.

From where we stand today, we wouldn't anticipate that the current foreclosure issues would create significant exposure for our title operation. If there is any exposure likely, we think we would see it in the area of increased legal expenses that would relate to, essentially, having to defend in a wrongly-executed foreclosure proceedings. And in the unlikely event of a worst-case outcome, where the Title company could be responsible for the exposure to a new buyer, the property was deemed to be wrongly transferred. Again, that would be our worst-case scenario. But in that instance we think that the various predictions built into the policy would protect the company from significant loss.

As far as the signing of indemnification agreement with lenders, we have yet to execute an agreement like that. In large part because we feel that the protections under the policy itself are sufficient to protect us from loss in these scenarios. But certainly we'll continue to revisit the indemnifications in this process throughout the cycle of these foreclosure moratoriums. That all being said, I think we're reasonably satisfied with the progress that we're seeing in the Title area and we think that we'll continue to be reasonably optimistic that this line of business continues to stabilize. With that, I'll take a second and turn it back over to Al Zucaro.

Okay, well there you have it. The story about -- the current story about our three major segments and their impact on the consolidated results of the company. As a closing comment, I might, as we usually do, point to the fact that the Old Republic balance sheet is as pristine as it's been for many years. The bond portfolio has got quite a bit of appreciation built into it because of the interest rate situation and the quality of that portfolio. As I mentioned before, with respect to General Insurance, and the same holds true for Mortgage Guaranty and Title Insurance, our reserve structure is in very good shape and we don't expect any significant deficiencies to develop to speak of.

And finally as you see book value per share, even though we've got this small loss to account for over the last nine months, as well as the fact that we have continued to pay cash dividends to our shareholders at a slightly increased rate so far this year; that even with those elements, book value is going up, and it's going up primarily because of the contribution from unrealized gains on the bond and the much smaller stock portfolio that we have at Old Republic. Having said that, I guess we'll, as we always do, open it up to any questions you may have there.

(Operator Instructions) And our first question today comes from Beth Malone with Wunderlich Securities.

Thank you. Good morning. Can I just get a little more clarification. I'm trying to understand. Obviously the claims in the mortgage insurance for this quarter were significantly higher than they have been in the past quarters. And I just want to understand, is that due to an acceleration or further deterioration in the mortgage environment? Or is it due to some kind of change in the timing of recognition of the mortgage claims?

Sure. This is Chris, Beth. I think one thing to do, certainly, is look at page four of the release, and then go down to the bottom of the table in the middle of the page and you can see the trends absent the impact of the captive commutations and pool terminations over the 12-month period. But with that I'll say, we certainly did see an increase in page in the quarter. And it was related to a couple of different things. One we use the rat and the snake metaphor, unfortunately, to describe the '06 and early '08 book, moving through the portfolio. And it can get choppy as that thing gets adjusted.

In the third quarter what we saw was an acceleration of paids, in large part due to an acceleration in receipt of documents for claims that were payable, but needed to have what we call the Chronology Docs Supply, just what went on in the process to verify the claim and pay it. That's a significant spike in the third quarter. And we've begun to see this isn't the first foreclosure moratorium that occurred. There was a big foreclosure moratorium in place as we tried to move all the HAMPs through the system. That came off early in the year I think, and I think we have some natural paids, as that little bubble in the moratorium worked it's way through the third quarter.

As a matter of trend, the trends that have existed to date, being the reduction in newly reported delinquents, really, since the beginning of '09; the improvement in cure rates that we've seen in 2010, those things continue to exist today. I might add that the point that Chris just made, about the speeding up and the verification providing to us the proof of loss, so to speak, is the same issue that we have tried to ascribe to the CCI program. And the fact that, to remember also that the speeding up of paid claims and Mortgage Guaranty is occurring in the context of its reserves still panning out just fine. We're still developing redundancies, perhaps at a smaller degree level than last year. But still redundant reserves. So there is no question that the increase in claim payments is impacting adversely the quality of the reserve structure.

Okay. So using your snake-rat analogy, are we closer to full digestion of the rat?

My sense is we're beginning to overwork the metaphor. But as we've said in the past and I said at the close of my comments, I think we'll -- I'm trying to get off the metaphor. But we'll continue to work our way through those bad books through 2011. And likely with the real estate market where it is, into early 2012.

Okay. And then on the title business, the whole foreclosure mess and this moratorium and that; as it relates to title, should we anticipate that the fourth quarter will have fewer title revenue because this whole process has been -- like it will get lumpy too, because all of the foreclosures that were supposed to take place are not, and then they'll have to take place in a rush at the beginning of '11 because of the controversy over the foreclosure paperwork?

That's a tough one to predict. Because, remember, there are a lot of parties who have influence in how this proceeds. But I think it's safe to say that if you shut off the foreclosure activity, you would be putting less loans out into the market, less new purchases, and that would reduce the overall market for all title insurers or anybody subjected to the swings in regeneration volume.

Let me make a specific point about the fourth quarter, though. Let's also bear in mind that, that turns out to be one of our slower quarters, typically. And then also, one of the wild cards in all of this, particularly as it effects title insurance, is the level of refinance activity. That so long rates stay at these low levels, you may still have a substantial number of loans to be financing throughout the country. Because I suspect a lot of people live in fear that rates are going to go up, and they may take advantage of this continued low-rate environment.

Okay, and then one last question and I'll get back in queue. Is the outlook on the overall -- the General Insurance and what you are seeing and in trucking and those areas -- because we're hearing a variety of responses in the third quarter. Some companies are arguing that things look like they are getting a little better in terms of demand and pricing, and some are saying it's not getting any better. And just what is it you are seeing in that market?

Well what we're seeing is, as I think we mentioned before, that is the fact that we don't see any further significant down trends in the rate structure, at least with respect to the areas we play in, the industries we service and the coverages that we provide. But so much, again, of our business is repliant on sales activity and employment activity, that unless that changes dramatically - and we're of the school that that's not likely to occur for a while, that we are on the slow boat to China when it comes to the economy -- we're not going to see any significant upside to the top line by virtue primarily of this economic situation we're in.

Okay. Thank you.

We'll go next to Bill Clark with KBW.

Good afternoon, guys. In the mortgage insurance segment, the two quarters prior to this you had managed to get the loss ratio down to the low- to mid-100% range. This quarter, obviously, it shot back up to higher, higher 100%, closer to 200%. Any thoughts as to where we might finish the year or start to see that ratio go to in 2011?

Well the most important thing there is, again, to go back and look at these quarters absent the changes created by the captive commutations in the pool terminations. I think your comment that we gotten it down to a much lower level in previous quarters -- I think those are largely reflective of the results of the terminations or the captive commutations. Again, the way to look at the real trend, as we've shown it on page four here, absent those various activities. As far as outlook, we would continue to anticipate this market will have a tough time getting it's footing. Certainly, we would expect some continued home price depreciation going forward, with that, and the job environment I think will slow the return to stability, balanced off somewhat by the seasoning of those older, higher risk thoughts.

Okay. Great. And second question. In your break-out of the premiums by line for General Insurance, it looks like there was a pretty big jump in the financial indemnity segment. Was that influenced at all by the clean-up you talked about CCI, or was there something else going on in there?

There was some -- as you may know or recall, though, that the CCI product, quite a bit of it, between 40% and 50% depending on the sources of the business, is subject to some sort of retro-type of premium adjustment. And when we had this spike in claim costs, in this latest quarter in particular, it triggers on some accounts, some additional premiums; what we would refer to as audit premiums, let's say, in other lines of insurance. So these were triggered by the retro-spective premium adjustment formulas that we have on some of this business. And that's the lion's share of that. We had a little bit of improvement in the portion of financial indemnity, which has to do with the GAAP coverage. That's the asset protection product for our automobile business, and the fidelity uncertainty was a nonevent. So it was mostly, in direct answer to your question, the retros on the CCI product that created it.

Okay, thank you.

(Operator Instructions) And we'll go next to Marc Snyder with Symphony.

Hi, guys, can you hear me?

Yes.

Just to follow-up on the mortgage questions. If I'm thinking about it, was there a change in the reserve policy that impacted the MI segment? Because if delinquencies are down, severity's down, risk and force is down, how else should I be thinking about it?

Well I think as we look at each quarter, we're looking at all of the things that impact the ultimate frequency in those loans. And certainly as this market moves along you've got the phenomenon of changes in the recision rate. And again as the bad books of '06, '07, and then the first quarter of '08, as they work their way through the system, the recision rate on the loans going forward, we would expect certainly to decline. As that declines, we would make adjustments in the reserving, reflective of the higher frequencies we might see in the embedded delinquents. So I think that's what you're referring to. You might have expected to see a bigger drop, but we make a judgement each quarter on the later stage delinquencies and what we think these recision rates would be, and have made some adjustments to increase those reserves.

Okay. And just one more quick question. Just on the severity of each paid claim, what has that been running at now? And what has it prior been in the last couple of quarters?

What we've started to see again and as time has gone on, we've noticed that the higher risk loans are the first to go to claim. As high risk loans were largely resident in the sand states. California, Florida, Arizona and Nevada. And those are the states with the higher loan balances. As those have worked their way out, we've seen severities begin to decrease, really over the last few quarters. Not dramatically, I would say, but consistently.

What that be severities in the 80% range, or maybe back down to 60% or so?

No, I don't have that in front of me. But I would think it's still around 100% but the size of the claims that have come down are the loan sizes get down to more normal levels.

Okay, great. And just last quick question. The MI business you're running now, what kind of R rate do you think you would get on that?

What I would tell you is the book we are writing now compares favorably to any book we've ever written. And I would think it even feels a little better than the book we wrote after the last catastrophic loss cycle. It has high FICOs, reasonable LTV's and very strong borrowers.

Okay. Thanks.

And our next question is from Cynthia Brown with Federal Home Loan Bank.

We missed that. You can repeat that? Hello?

This is Cynthia Brown from the Federal Home Loan Bank.

Okay.

I have one quick question on the title insurance. Seeing as how a majority of the composite ratio on that is the expense ratio. How do you -- Or, what are your projections for the expense ratio going forward with the moratorium? How high do you expect that to go, or what are your ranges for that, given the whole foreclosure debacle?

I would tell you, I think the trends we've experienced in the past would be the trends that we would expect to see if the future. As I mentioned, if anything comes out of this, it would be an increase in legal fees. And I wouldn't think, at this point that would be a material impact on the company.

And to add to that, I'm sure you realize that with some 60% plus of our business in Title Insurance coming from the agency distribution channel, that a big chunk of our expense ratio comes from the fees we pay to those outside producers. So to the extent that the topline from those areas suffers by virtue of the issues that you are addressing, or any other matter, that would have an impact on the topline. And then the expense would follow suit. So you should expect to see relative stability in our expense ratio.

So the expenses from legal fees is a much smaller portion of the expense ratio?

Oh, yes. Indeed.

Okay. Thank you.

And we'll take a follow-up very from Beth Malone from Wunderlich Securities.

Okay, thank you. Just a couple quick things. I just want to confirm, when you look at results for the mortgage insurance and compare it to a year ago, the combined ratio, has that been restated for 2009 to reflect those re-insurance commutations?

No. They just throw through on a prospective basis. If I understand the question.

Well, I guess my question is, when you reported second quarter 2009, the composite ratio for mortgage insurance was significantly higher than what you're using as a comparison for the this -- I'm sorry, for the third quarter of 2009 compared to what you are using in the press release to compare it to today.

I think what you may be looking at, Beth, is if you recall, we had to change in the manner in which we handle the captives, re-insurance arrangements that we affected in the third quarter of last year.

Oh, okay.

You remember?

Yes.

And then we, in effect, ended up restating those numbers. And so, really, to compare on an apples-to-apples basis, with this quarter in particular, you should use the old numbers. To compare on a year-to-date basis and you should use the new numbers.

Okay, all right. All right.

I think that's what's happening in your comparison.

Okay, then another question on the Consumer Credit Indemnity, you haven't written a new policy in that business since 2007. Is that right?

Correct.

So we should view consumer credit as a runoff business?

It is in that stage right now. Until we resume writing business, and that's going to be, as we've said before, predicated on one, our redoing the pricing structure of that business and the policy features of that business on one hand, and secondly on loans being made that the lenders would want the CCI coverage for. And of course no such loans to speak of are being made nowadays.

Okay, so --

Lines of credit and things like that have not been resurrected by any stretch of the imagination

Okay, so there's -- But I guess I was expecting at some point we would see it separated out from the General Insurance completely.

Yes, when it comes -- when it becomes immaterial we will do that.

Okay.

We're still writing I think some $60 million, $70 million annually of basically renewal CCI premiums as we speak. So it still accounts for 7% to 8%, I guess 6% I should say, of our total volume.

Okay. All right. Well that's helpful. Thank you.

Your welcome.

(Operator Instructions) And we have no more questions at this time. So I would like to turn the call back to Mr. Zucaro for any concluding remarks.

Well I think we've said what we set out to say, and we're happy that we got as many questions that we did, and hopefully we answered them to everyone's satisfaction. So on that note, we will bid you farewell until the next session three months from now. You all have a good day.

This concludes today's call. We thank you for your participation.