CASE STUDY of Perception vs. Reality (Old Republic Insurance, “ORI”)

Perception vs. Reality

Old Republic (ORI) pulled their spin-off and looked what happened

What changed? I would advise you to listen to the current conference call: http://ir.oldrepublic.com/phoenix.zhtml?p=irol-eventDetails&c=80148&eventID=4797341 which will be available until July 3, 2012. It is a classic of how analysts view the stock price and the owner/operator/management views the reality of their business.  Old Republic (“ORI”) announced a spin-off of their money-losing Mortgage Guaranty Insurance business (“MGI”) but then on Friday decided not to go through with the spin-off for various reasons.

As you can see above in the short-term chart of ORI, the stock moved up upon announcement of the spin-off and the price neared $11 before plunging to below the pre-announcement price.

No matter what your assessment of intrinsic value was or is now, the mathematics of future cash flows has never changed. Actual risk hasn’t changed, but the PERCEPTION of risk has. If you read through the conference call transcript, you will see that several analysts/investors do not understand how run-off insurance operates. Run-off means that no new insurance is underwritten while claims of the old (past) insurance are paid down from stated reserves.  ORI will pay claims initially at 50 cents on the dollar as per the orders of their insurance regulators.

Ironically, management (Aldo Zucaro – Chairman of the Board, Chief Executive Officer) bought shares last month around $9 to $10 per share probably never guessing that shareholders would respond to the announcement as they did. Note his exasperation in having to repeat over and over that the economics of the business have not changed. Note the gap between perception and reality. I have highlighted certain passages of the transcript for emphasis. Markets are efficient?

See the case study here:

Case Study of reality vs perception for Property Insurer Old Republic_

Review of Old Republic here: ORI_VL, ORI_May 2012, 1Q12 FINAL Financial Supplement, and ORI_Morn_Spin

Mortgage Indemnity Business in Run-Off

Details of Old Republic’s Mortgage Guaranty and Consumer Credit Indemnity Businesses renamed Republic Financial Indemnity Group, Inc. (RFIG). This will help you understand ORI’s deferred payment obligation (“DPO”) for the run-off of its MGI business.  The DPO keeps the Mortgage Indemnity Insurance unit SOLVENT via the orders of the insurance regulators and in terms of STATUTORY ACCOUNTING.

The Statutory Accounting Principles are a set of accounting rules for insurance companies set forth by the National Association of Insurance Commissioners. They are used to prepare the statutory financial statements of insurance companies. With minor state-by-state variations, they are the basis for state regulation of insurance company solvency throughout the United States.

You will then understand the lack of risk to the rest of Old Republic. Statutory accounting is the reality not GAAP. financial_supp_stat_exhibit_032112 and the Press Release of Old Republic’s Partial Leveraged Buyout and planned spin-off of its RFIG subsidiary’s stock to ORI shareholders: may_21_2012_ori_press_release

Some say the market is efficient. What do YOU think? Who are the sellers?

Post Script: I am backed up this week so I might be light on the posting. Be well and keep learning every day.

UPDATE 1#

Moody’s lowers debt ratings on Old Republic

NEW YORK (AP) — Moody’s Investors Service on Wednesday lowered its senior unsecured debt ratings for Old Republic International Corp., citing the company’s decision to withdraw plans to spin off a subsidiary.

The Chicago-based insurance underwriter announced last week it changed plans to spin off Republic Financial Indemnity Group Inc. The move came after stakeholders raised concerns that the spinoff would not be in their benefit.

The reversal prompted Moody’s to downgrade Old Republic’s senior unsecured debt ratings one notch to “Baa3” from “Baa2.” That’s the lowest possible investment-grade rating on Moody’s scale.

The ratings firm also lowered the insurance financial strength ratings of Old Republic subsidiaries Old Republic General and Old Republic Title by one notch to “A2” from “A1.”

Moody’s has a negative outlook on the ratings for Old Republic and its principal subsidiaries, which means there’s a 40 percent chance that the ratings could be lowered in the next 18 months.

The ratings firm said its outlook reflects continued risk of liquidity strain at Old Republic International, should regulators find that capital levels its subsidiary, Republic Mortgage Insurance Co., falls short of requirements, triggering an early redemption of the parent company’s senior notes.

Moody’s believes liquidity options exist in such a scenario but said such an event would still place pressure on Old Republic International.

“The intended spinoff would have helped protect Old Republic’s bondholders and insurance policyholders from further deterioration at the troubled mortgage insurance operation,” Moody’s analyst Paul Bauer said.

The risk of financial strain at Old Republic International could strain its subsidiaries’ financial flexibility, Moody’s noted.

Moody’s affirmed Old Republic subsidiary Manufacturers Alliance Insurance Co.’s insurance financial strength rating of “A3.”

It also maintained an “A3” rating on Pennsylvania Manufacturers’ Association Insurance Co. and Pennsylvania Manufacturers Indemnity Co.

Old Republic shares ended regular trading down 4 cents at $8.29. The stock added 5 cents to $8.34 after hours.

Liquidity fears ebb at Old Republic

By Jochelle Mendonca and Sharanya Hrishikesh

(Reuters) – Old Republic International reassured investors that scrapping plans to spin off its money-losing mortgage insurance business would not lead to a liquidity crisis as regulators were unlikely to seize the unit.

The insurer had planned to separate the unit and had even entered into a deal to sell a fifth of the business in a leveraged buyout but shelved the plan following stakeholders’ objections.

The company’s stakeholders include its regulators, the government-backed Fannie Mae and Freddie Mac and bank customers.

Regulators in North Carolina have already placed the unit under supervision. It is now only allowed to pay claims at 50 cents on the dollar to preserve capital, leading to investor fears that the unit would be seized, triggering a default under the company’s debt covenants.

Old Republic eased those concerns on a conference call to discuss the canceled spinoff.

“We’re comfortable, based on our discussions (with our regulators), that receivership is not in play,” Chief Executive Aldo Zucaro said.

He expressed confidence that the company would be able to either refinance its debt or amend the terms, should a default occur.

Old Republic said the mortgage insurance (MI) unit, which stopped writing new business when its capital levels cratered last year, would continue to lose money for the next two years.

“By (2014), our total loss since 2007 will have been $1.7 billion, versus the total accumulated profit of $1.8 billion booked in the first 26 years … of our mortgage insurance journey,” Zucaro said.

The company said almost all its statutory capital – the standard claims-paying metric – comes from deferred claim payments ordered by regulators. Deferred payments count as a liability under generally accepted accounting principles.

On a reported basis, the company said its mortgage insurance unit has no capital and that it does not have the funds to add to the business.

“To just keep the company solvent, you’d have to come up with $250 million, which we are not committed to doing,” a company executive said.

UNHAPPY INVESTORS

But even as the MI unit’s stakeholders got their way with the scuttled spinoff, many Old Republic shareholders are unhappy at the prospect of being saddled with the business for the foreseeable future.

Investors from hedge funds SAC Capital, Anchor Capital, Divine Capital and others grilled company executives on options for the unit, including voluntarily placing it into receivership.

“Why is it not better to simply spin this out and go out to your bondholders and amend the covenants if necessary or to go in receivership?,” Darius Brawn from SAC Capital asked on the conference call.

Even a sale of the business to investors specializing in run-off situations, where they just manage the existing book till the policies are exhausted, seems unlikely.

“I think the possibility of a runoff (investor) buying a mortgage guarantee business with regulatory approval is remote,” an Old Republic executive said on the call.

The company said it sees no need to amend its debt covenants in advance of a seizure, something shareholders asked it to consider, because it does not believe the default will occur.

“One of our sayings around here is that you don’t just jump off the roof because you’re afraid you’re going to fall off,” CEO Zucaro said.

“We don’t think we’re falling off the roof. So we’re not jumping.”

(Reporting by Jochelle Mendonca and Sharanya Hrishikesh in Bangalore; Editing by Viraj Nair, Anil D’Silva and Supriya Kurane)

 

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