It's all about the ratings

Jeffrey Tischler looks at 1998 as a "coming out" party for the title insurance industry.

And while the phrase seems colorful for a business that outsiders might consider mundane, it does describe the activity and growth of the business in a thriving real estate market.

Tischler is executive vice president, CFO and treasurer for LandAmerica Financial Group Inc. in Richmond, Va., which became the largest title company in the country in 1998. In October, LandAmerica was formed when Lawyers Title Corp., the holding company for Lawyers Title Insurance Corp., acquired Philadelphia-based Commonwealth Land Title Insurance Co. and Transnation Title Insurance Co.

A few months before, Alleghany Corp. spun off Chicago Title Corp.

LandAmerica and Chicago Title represent the creation of two top players in the title insurance industry, and they have garnered lots of attention.

"At the same time, we all had soaring stock prices," Tischler says. "We had to do a stock offering and do a road show across the country, and that got a lot of analysts to follow us. The investment community started seeing us as an industry that could really profit from a healthy real estate market, and also profit from a good interest rate environment."

The healthy market for real estate is keeping this industry busy, and bolstering the need for title insurance ratings firms that measure the financial stability of underwriters for commercial and residential real estate markets.

The need for ratings Title insurance has been around for about 100 years, but ratings are a new phenomenon that first became available in 1992. The criteria may vary slightly among ratings firms, but they are essentially looking for the same critical information: the financial soundness of a title insurance company.

At the moment, ratings tend to be most important in large commercial transactions. Tischler said many commercial customers are using outdated formulas to make decisions about the strength of title underwriters.

"These may not have been updated in a very long time, and they may no longer be truly indicative of a company's financial strength," Tischler says. "We like ratings because they are objective."

Ratings for title insurance companies may not worry many individual home buyers, but Tischler said they are increasingly important for nationally-based residential companies. These companies are an emerging customer sector that is equally interested in title company ratings because they may buy title insurance for 100 residences at a time.

The thriving market and interest from residential companies are newer trends, but practicality drives interest in title ratings. Originally, the Federal National Mortgage Association (Fannie Mae) needed a list of strong firms to use in its own transactions.

Equally important is the continuing interest among investors in large transactions and the proliferation of the securitization market.

How they rate Title ratings firms measure an underwriter's financial stability and claims-paying ability. Essentially, they review a company's ability to meet obligations on a timely basis. Industry experts said the criteria used by different ratings agencies is very similar, and the criteria is not quick to change.

Demotech Inc. of Columbus, Ohio, claims it was the first to start rating title firms. President Joe Petrelli said criteria for its ratings include:

a. Current assets versus current liabilities

b. The quality of assets

c. Whether there are investments in subsidiaries

d. Distribution systems

e. Loss experience

f. Statutory premium reserve requirements

g. The quality of reinsurance

Petrelli said Demotech looks at more than profitability when evaluating a company. Balance sheet strength and financial integrity are important. While the company does need to have proper assets and revenue, it also needs a long-term strategy to ensure profitability.

"We've taken the position a small, conservative, well-run company can be just as sound as a large well-run company," Petrelli says.

Harry Comninellis, an analyst for Moody's Investors Service, says criteria for ratings rarely change year to year unless there is a regulatory change or an accounting change.

"The more important issues year to year tend to be changes in management's view of the industry and their approach to business," Comninellis says. "The numbers are important and will tell you quite a bit. But looking at management's view and what their approach is and how to best compete in that environment - those tend to be the bigger issues."

When considering numbers, Comninellis says he looks at the balance sheet and studies asset allocation and capitalization.

Moody's covers the six national title insurance firms, which Comninellis says command about 90% of the market. About 60 or 70 other underwriters share the remaining business.

LACE Financial Corp. of Frederick, Md., continues to be the only ratings firm that does not charge for its ratings. President Barron Putnam holds firm to his belief that receiving payment for a rating leads to biases in the rating process.

"It's hard to be unbiased when money changes hands," Putnam says. He has voiced concern that ratings are used more for marketing purposes.

When considering an underwriter, LACE studies liquidity, asset quality, trended claims and capital and earnings expenses. "The companies with strong balance sheets usually have high levels of capital, strong earnings with good investment income," Putnam says.

LACE has introduced a product called Commercial Capacity Ratings which focuses on the capacity of title insurers to write large policies and assume reinsurance for major commercial real estate mortgage lending transactions. LACE claims this is the first such service of its kind.

Other ratings services include Duff & Phelps Credit Rating Co. of Chicago and Standard & Poor's of New York.

A healthy economy Putnam, who is an economist, says there is concern that low interest rates, which have fueled interest in the robust real estate market, may begin to rise. And even if they don't, high levels of consumer debt worry many. With the stock market at record levels, a change could erode consumer confidence.

"I think a lot of agents are smart," Putnam says. "They know things are at very good levels now, and given that this is a very cyclical industry, when things change they are likely to change for the worst. That worries them. When interest rates rise you won't have a lot of refinancing and repurchasing of new homes, and revenue will be off for the title companies."

For title companies, Putnam said it's not a good time for them to leverage themselves because increased expenses could hurt if revenue begins to fall.

Tischler said if rates do rise, they will likely do so in a more orderly fashion than in 1994 when the real estate industry experienced a three-year boom based entirely on refinance transactions.

"The economy during that period had not been healthy, and when it's not healthy real estate isn't healthy," Tischler says. "The core of our business is resale. In 1994, interest rates went up wildly, refinance transactions dropped drastically and we were left with not much else."

Tischler says that at the time his company had to cut costs by laying people off and closing unneeded facilities.

Mergers & acquisitions If LandAmerica and Chicago Title are any indication, the title insurance industry is one of many using mergers and acquisitions for growth and the consolidation of services.

Petrelli says these transactions can affect a title company's rating. "You have a well-respected company that acquires a company that was small and didn't have as good a rating; you have to factor in they are associating with someone who is improving their situation," he says. "But that doesn't change the mediocre company immediately. We have to use some judgment in how we assign ratings to the newly acquired company."

The cultures of the two companies and the plans for the future are among the factors at play. "The truth of the matter is you can't change a company's culture and situation just by acquiring them," Petrelli says. "How will they change their practices? How will they infuse capital into the company? We had one situation where a company that was a good company was bought by a property and casualty company, and it made a capital contribution to the underwriter. That shows a commitment."

Using ratings Tischler says LandAmerica factors in ratings when making decisions about day-to-day business.

"If we wanted to borrow a lot more money, we'd want to talk to the rating agencies first to see how they would feel," Tischler says. "Right now we have a low amount of debt."

Royal Abstract of New York is a title insurance agency that draws from underwriters across the country to provide coverage for clients.

President Martin Kravet said ratings do not decide whether a title insurance company gets business. Rather, ratings are used as a source of information. He said Royal considers financial strength based on revenue, policy holder surplus amounts, money in reserve and outstanding obligations.

"While there are some companies with higher ratings than others, it doesn't mean their financial strength is larger," Kravet says. "It merely means that according to a certain ratings schedule their claims-paying ability might be stronger. Nationally, there are players who are very familiar with title companies and might insist on a certain insurer or group of insurers who operate on a national basis compared to those on a local or regional basis."

More important to Kravet than literal ratings are reputations.

"We don't focus on the ratings for particular companies when deciding which to use," Kravet says. "We're aware of the financials of our underwriters and continue to utilize those companies which are known to the marketplace as the leading title insurers. Unless we receive notice that a company's rated below investment grade, the various ratings each company receives are not the determining factor."

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