Old Republic International Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Old Republic is an insurance holding company operating through General Insurance, Title Insurance, and the RFIG mortgage-guaranty and consumer-credit run-off businesses.
Financial results and position
- Q2 revenue: Operating revenues were $1.324 billion, up 10.2% year over year; total revenues including realized investment gains were $1.462 billion, versus $1.224 billion.
- Q2 earnings: Net income was $193.9 million, or $0.67 diluted EPS, compared with a $34.0 million loss, or $0.13 loss per share, in Q2 2012. Net operating income, a company-defined non-GAAP measure, was $104.8 million ($0.37 diluted EPS); after-tax realized investment gains added $89.1 million ($0.30 per diluted share).
- First half: Operating revenues increased 9.9% to $2.590 billion. Net income was $250.2 million, or $0.88 diluted EPS, versus a $33.5 million loss a year earlier. Net operating income was $158.0 million ($0.57 per diluted share), with $92.1 million of after-tax realized gains.
- Underwriting: The consolidated composite ratio, including RFIG run-off, improved to 92.6% in Q2 from 113.9%; excluding run-off, it was 96.1% versus 98.4%. Ratios below 100% indicate underwriting profit.
- Segments: Q2 Title operating revenue rose 27.7% to $522.6 million and pretax operating income increased to $40.4 million from $22.5 million. General Insurance pretax operating income was $63.1 million, up from $59.6 million. RFIG run-off reported $55.4 million pretax operating income versus a $160.2 million loss, driven principally by lower claims and favorable prior-reserve development.
- Cash flow and liquidity: First-half operating cash flow was $278.3 million, versus $130.3 million in 2012. Investing cash flow was negative $173.5 million and financing cash flow negative $93.2 million; cash ended at $112.7 million. Cash and invested assets totaled $10.819 billion.
- Debt and equity: Debt was $570.0 million, including $550 million of 3.75% convertible notes due 2018. Management reported debt-to-equity of 15.9%. Shareholders’ equity was $3.585 billion, down 0.3% from year-end 2012; book value per share was $13.95, down from $14.03. The decline in accumulated unrealized investment gains was an important factor.
- Investment income and dividends: First-half net investment income declined to $158.2 million from $170.9 million, reflecting low yields. The quarterly common dividend was $0.18 per share.
Material changes and unusual items
- Realized investment gains were $137.1 million pretax in Q2 and $141.7 million for the first half, mainly from equity-security sales. Of the first-half total, $131.3 million reflected an accounting adjustment for gains on securities previously impaired in 2008; these gains materially boosted reported net income and are not presented by management as representative of core operations.
- Rising interest rates reduced the fair value of investments and contributed to a $175.1 million first-half other comprehensive loss. Fixed-maturity unrealized losses were $57.6 million at June 30, compared with $6.5 million at year-end 2012; the company recorded no other-than-temporary impairment charges in the periods shown.
- RFIG and its mortgage-insurance subsidiaries remain in run-off and do not write new business. The North Carolina insurance regulator’s corrective plan provides for 60% cash payment of settled claims and retention of the remaining 40% as deferred payment obligations; the accumulated DPO reserve was $443.0 million at June 30. RFIG’s strong reported improvement included substantial favorable reserve development, so results may not reflect recurring performance.
- No specific earnings guidance was provided. Management emphasized long-term underwriting and financial strength, and noted that future results depend on claims trends, interest rates, housing and mortgage conditions, competition, and other economic and legal factors.
Risks, contingencies, and controls
- Management said RMIC’s statutory impairment could, under specified circumstances, lead to receivership and a default under the convertible notes, potentially accelerating repayment. Management believed the regulator-approved supervision and corrective plan made this unlikely in the foreseeable future, but gave no assurance; it was considering amendments, additional financing, or intercompany funding options.
- Material litigation includes title-insurance class actions and mortgage-insurance disputes and arbitrations. A Bank of America arbitration demand sought at least $63.8 million, plus other unspecified damages. The company said it did not believe the identified actions would have a material adverse effect, while noting potential liabilities generally could not be reasonably estimated. A Chase dispute was settled without monetary payment in July 2013.
- Insurance loss reserves are estimates subject to uncertainty, particularly for long-tail general-liability claims, mortgage claims, rescissions, and litigation. The filing identifies reserve adequacy and recoverability of reinsurance as significant estimation areas.
- Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter. The company reported no material change in risk factors from its 2012 Form 10-K.
Important facts for investors to verify
- How much of earnings growth is sustainable operating improvement versus realized gains and favorable RFIG reserve development.
- Whether mortgage-insurance claim trends, deferred payment obligations, and regulatory supervision evolve as assumed, and whether any development could affect note-default risk.
- Whether general-insurance reserve trends and investment fair values withstand ongoing claims inflation and interest-rate movements.
- The status and potential exposure of the significant mortgage-insurance, title-insurance, and related legal proceedings.
- Parent-company liquidity, access to regulated-subsidiary dividends, and funding capacity if debt repayment needs increase.