Don't Write Off This Mortgage Insurer

One way to empty a crowded theater: Shout the word mortgage. So imagine how hard it is for an insurer -- even one with two other business lines -- to shake the taint.

Old Republic International specializes in property-and-casualty, title and mortgage insurance. But you would hardly know that it has those other business lines, given how much attention mortgage insurance garners. The stock's 29% price drop in 2008 (and 51% fall from its all-time high in mid 2007) signals that "it's trading on the mortgage news," notes Ralph Shive, manager of 1st Source Monogram Income Equity fund.

It will take a housing revival to pull Old Republic (symbol ORI) out of its funk. Still, it's a company that value investors should keep an eye on. The current price leaves Old Republic selling at just half of its book value per share -- a temptingly low ratio that's less than half the average for insurers, according to Morningstar. And the $11 stock's dividend of 68 cents per share gives it a 6.2% dividend yield. One signpost to watch will be its second-quarter earnings report on July 24. Analysts expect it to report a 5-cents-a-share loss.

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Mortgage insurance is a financial guarantee lenders require of borrowers who have less than a certain amount of equity in their homes. Should a borrower default, the mortgage insurer will step in. But with more borrowers unable to make good on their obligations, claims are rising. Foreclosure activity surged 48% in May compared with a year ago, according to RealtyTrac, an online marketplace for foreclosure properties.

Though Old Republic's mortgage subsidiary accounts for 14% of revenues compared with the 59% that property and casualty generates, the possibility of even more widespread mortgage defaults weighs heavily on the stock. It's still too early to even guess at what level defaults will peak.

Some investors and analysts fear that to stanch the hemorrhaging of capital from this unit, Old Republic might be tempted to shift capital from its profitable property-and-casualty business. That would weaken the entire firm. But Old Republic chief executive Aldo Zucaro assured investors in April that "we currently have the necessary capital-management flexibility to add funds to our mortgage segment, to at once repair the gashes that are caused by the greater claim costs as well as to provide necessary fuel for the expected rise of risk."

Investors such as Shive say Zucaro can pull off such measures. They note that Old Republic's stock is faring better than that of other mortgage insurers. By most accounts, Old Republic's underwriting standards were more stringent than that of others in its industry, even during the mortgage refi heyday. "We think they've got staying power, and there won't be any asset write-downs," says Shive.

And with the property-and-casualty insurance as a buffer -- the title-insurance business has been on a slide since 2003 due to a slowdown in refinancing and a lack of home sales -- Old Republic can withstand a lot of hits before the company truly begins to suffer. "Old Republic's baseline is its general insurance, which is giving it a lot of ballast in a very stormy sea," says Scott Barbee, portfolio manager of the Aegis Value fund.

With $400 million in pretax revenues coming from the property-and-casualty segment, at today's $11 a share, "it's like getting the two other businesses for free," Barbee says. Yet investors aren't sure that's enough. "There's the perception that the company will raid the capital of one business to pay for the losses in the other," Barbee adds.

Without a doubt, Old Republic is a turnaround play. In the first quarter of 2008, the firm lost 8 cents a share, far more than the 2-cent loss analysts had anticipated. The company earned 46 cents a share the year before. For all of 2008, analysts expect a loss of 15 cents per share.

There is a lot at stake in simply surviving the mortgage debacle as some mortgage-insurance companies get out of the business. Says Barbee: "There might be benefits that accrue to the last man standing."