Two years ago a group of financial hotshots including former ITT Chairman Harold S. Geneen and American Can Vice Chairman Gerald Tsai raised $271 million to buy a little known Los Angeles-based company called Ticor.
Ticor ran the country's leading title-insurance company, but what attracted the financiers was Ticor Mortgage Insurance Co., which accounted for less than half of its revenue.
Ticor Mortgage, which has since changed its name to TMIC, had great potential for growth and profits and "was to have been the icing on the cake several years down the road," said Winston V. (Bud) Morrow, Ticor's president and one of the investors.
Less than two years later, the Ticor buyout has gone bust. TMIC faces more than $160 million of losses on loans it insured for Equity Programs Investment Corp. (EPIC), the Falls Church real estate syndicator. EPIC's default on more than $1 billion worth of mortgage loans precipitated the worst crisis ever in the mortgage insurance business.
The potential losses to EPIC amount to about 80 percent of TMIC's roughly $200 million in surplus and reserves to pay claims. The downside risk is so great that California insurance regulators have ordered TMIC not to issue any new mortgage insurance policies. Credit agencies have sharply downgraded their ratings on TMIC's claims-paying ability.
Ticor executives say they are hopeful that an EPIC bailout plan they are working on with other creditors will enable them to cut their losses. But they acknowledge the situation is bleak.
"It's not an impossible situation, but it will be difficult," Morrow said in a recent interview. "In this situation, I think you have to adopt a pretty pessimistic and guarded posture. But with the potential of a workout happening, I have some reason to be less pessimistic."
As Morrow and other Ticor executives are quick to point out, many other companies stand to lose from EPIC. Mortgage Guaranty Insurance Corp. and a half-dozen other mortgage insurers, the Federal National Mortgage Association and dozens of savings and loan associations that bought EPIC mortgages face losses.
For TMIC, though, the EPIC loans represented the culmination of what many in the industry say was an increasingly risky course of expansion.
Ticor has commissioned a study by their outside counsel -- the law firm Jones Day Reavis & Pogue -- into how the company became so exposed at EPIC. Ticor executives won't comment on the details of the situation.
But many in the industry are asking tough questions:
How did the company acquire so much EPIC business, when diversification of risk is the first principal of insurance? Why did senior management apparently ignore warnings from within about EPIC months before its collapse last August? Did the debt-financed buyout of Ticor early last year cause the mortgage unit to turn to risky insurance practices to jack up premium dollars needed to make the investment profitable?
None of these issues was apparent in February 1984 when Ticor was purchased by its present owners. Geneen, Tsai and Morrow -- a former head of the Avis car rental company -- and other lesser-known investors acquired the the company from Southern Pacific Corp. in a leveraged buyout.
A leveraged buyout is a purchase financed with borrowed money that is paid back from future profits or the sale of company assets.
The Ticor buyout group sold off some of the company's assets -- including its headquarters building -- and borrowed $100 million from a group of banks, led by Manufacturers Hanover. A critical part of the financing came from American Can, which invested $50 million in Ticor. For its part, American Can got not only four seats on the board of directors, but also options to buy all of Ticor's stock. The prospect of some day selling the company to American Can was the potential payoff for the investors, who stood to make millions if American Can exercised its options.
The deal did not sit well with California insurance regulators, who expressed reservations at the time about the amount of debt the transaction would leave Ticor. They approved the deal after getting pressure from the company through the governor's office and concluding that the well-heeled investors had the wherewithal to carry the debt, said Richard J. Roth, California's assistant insurance commissioner.
At the time of the takeover, TMIC enjoyed an enviable niche in the industry as an aggressive marketing-oriented insurer. From its inception in 1973, Ticor Mortgage grew very fast, accumulating total assets of more than $250 million by 1985 and becoming in the process the nation's third-largest mortgage insurance firm.
TMIC benefited directly from the high inflation rate and rapid growth in property values that prevailed in the 1970s -- and paid dearly when these trends halted in the '80s.
Today's private mortgage insurance industry emerged in the 1950s to fill a need by savings and loan associations to protect low downpayment mortgages not insured by the Federal Housing Administration or the Veterans Administration. Mortgage insurance companies insure up to 25 percent of the value of mortgage loans on the assumption that the remainder of the loan will be covered by the value of the house. Savings and loan are thus protected if borrowers default on their mortgage loans and home buyers are able to get mortgages with downpayments of only 5 or 10 percent.
Ticor was one of the most aggressive mortgage insurance companies, according to industry analysts and executives. Compared with other companies, they said, TMIC insured a high number of loans with only five percent down payments. TMIC veered into offshoots of traditional mortgage insurance, insuring an increasing number loans to investors rather than just owner-occupied homes.
The high-growth strategy worked until 1981 and 1982, when the recession took the inflation out of the real estate market and the economic slowdown caused more buyers to default on their mortgages. TMIC and other companies have been stung by escalating claims.
By 1984, most companies in the industry, including Ticor, began tightening their underwriting standards in an effort to root out the high-risk loans. Though TMIC profit margins were not wide, industry analysts say the company weathered the storm in better shape than many other companies.
A credit study issued by Moody's Investors Service last March, less than six months before EPIC collapsed, reported that TMIC stood exposed to a greater-than-average risk. But Moody's analysts concluded that TMIC was a "very solid company" and gave it a high rating -- A2 -- on its claims-paying ability.
William J. Fitzpatrick, who at that time was the parent's general counsel but has since taken over as the mortgage company's chairman, said the company's balance sheet remained strong until very recently.
"We were concerned about the historically high rate of delinquencies, but we didn't view that differently than any other mortage insurance company. It was simply a problem that had to be dealt with," he said. "We had no reason to believe that our mortgage insurance company's portfolio was any different than any other mortgage insurance company."
Beneath the surface, however, Ticor was beset by some serious problems. Throughout 1983, '84 and '85 its insurance portfolio underwent a significant shift. The company insured an increasing number of loans issued by an obscure real estate syndicator in Virginia, EPIC.
EPIC had been a customer of Ticor Mortgage since the 1970s, but only a minor one until a couple of years ago, according to former executives.
EPIC set up real estate partnerships to buy model homes from builders and sell them to investors as a tax shelters, financing the purchases with low down-payment mortgages insured by TMIC and other companies.
When EPIC's affiliate Community Savings and Loan got into trouble as a result of the Maryland savings and loan crisis in May, the EPIC empire quickly collapsed. EPIC partnerships defaulted on $1.4 billion of mortgage obligations, leaving Ticor holding the insurance bag on as much as 40 percent of the EPIC loans.
Ticor is now negotiating with EPIC creditors and other insurers over a plan to cut the losses, but there is little prospect that Ticor will get off scot-free. California regulators have ordered TMIC not to issue any more mortgage insurance and say they may take over the company. Even if TMIC has enough money to pay off the EPIC claims, its ability to pay off other claims is in doubt, regulators and analysts say.
Fitzpatrick and Morrow have been mum about EPIC, except to say that they and other members of TICOR senior management weren't told about the EPIC dangers by mortgage company's executives until August, after it was too late.
According to former executives, the risks of the EPIC coverage was known in the mortgage unit for months before they became public last August. Concerned about the EPIC loans, the mortgage unit's management, along with two other insurance firms, ordered a special study in the fall of 1984 by the accounting firm of Touche Ross & Co. Completed in April of 1985, the Touche Ross study outlined many of the risks that subsequently brought down the real estate syndication outfit.
Even earlier than that, concern had mounted within the mortgage insurance company over the amount of risky loans insured by TMIC. Claims from bad loans were soaring. Ticor paid more than 2,700 claims in 1984 -- on about 102,000 written policies -- compared with 320 on 41,000 policies just four years earlier, according to a former top-level executive.
"They had absolutely no interest in the type of business they were putting on the books -- the quality, the integrity, the price," said the executive, who asked not to be identified. "The underwriting standards went out the window. They were doing deals just to do deals. . . EPIC was only part of a lot bigger problem."
Another executive, Maurice McGrath, until 1983 the company's senior vice president in charge of underwriting, said he had long worried that the company was devoting too much attention to marketing and selling insurance at the expense of careful risk analysis and underwriting. A particular source of concern to McGrath, was the company's growing coverage of investor loans, like the EPIC mortgages.
McGrath said he was "dead-set against" insuring investor loans, which he said were frequently very speculative and were contrary to the original principals of the business. He said he raised his worries with senior management and TMIC's board of directors. "All I can say is that they kept of doing it," he said. "I left. I just had a philosophical difference with that."
McGrath's warnings did not go entirely unheeded. By the summer of 1984, the company had tightened its underwriting standards and stopped insuring investor loans, Fitzpatrick said. Fitzpatrick acknowledged, however, that TMIC continued insuring the EPIC loans, even though the company's stated standards forbade doing so.
Richard R. Lorenz, who at the time was TMIC's director of financial planning, said he and other executives began to worry about the company's snowballing exposure at EPIC. By 1983, EPIC was Ticor's third-largest customer, bringing in $1.4 million a year in premiums, according to an internal company memorandum.
In early 1984, Lorenz said, he and some other officials paid a visit to EPIC's Falls Church headquarters for a first-hand look and didn't like what they saw.
Lorenz said he was unable to obtain consolidated financial statements for EPIC and its myriad affiliates. Nor, he found, had TMIC inspected the properties mortgaged by EPIC. A memo prepared by one of his subordinates examined one of the EPIC partnerships and concluded that it financed its entire purchase with borrowed funds-an extremely risky practice. If the properties did not appreciate in value as fast as EPIC executives projected, "there will not be sufficient cash on sale to pay all debt obligations," the memo warned.
"I expressed tremendous reservations about what was going on," said Lorenz, who feared TMIC was "gambling the entire net worth of the company" on EPIC.
Why Ticor continued to take on EPIC business even these alarms were raised is unclear. Raymond Rodeno, who resigned as TMIC's chief executive after the company's troubles became public last August, has declined to discuss the situation.
One theory advanced by many company observers, is that TMIC and EPIC shared an unusually close relationship that may have blinded it to the risks of the EPIC partnerships. The two companies worked out of the same office building in Falls Church, and at least two former TMIC officials -- Leonard Meltz and Margaret Betchley -- left to work for EPIC.
Senior management may have been lulled by the fact that EPIC had never filed for an insurance claim. "The track record said no losses," pointed out Michael Molesky, an analyst with Moody's.
The leveraged buyout of early 1984 provided added incentive to take on the EPIC business, Moleski and others said.
The more profits the mortgage unit showed, the more likely American Can would exercise its options to buy the whole company. "The leveraged buyout was corrupting things," said Lorenz. "Everything that was done by the company was directed at an early exercise of the options" by American Can.
"They really had a motive to develop the company fast after they bought it," said another mortgage industry executive familiar with the company. "It just seems to me from what I've been told that they were just hell-bent for volume."
Lorenz added, "This was the driving force, so that people who raised a peep would be ostracized." The problem, he added, was that the EPIC loans "violated principal number one of insurance -- you've got an enormous concentration of risk. If [EPIC] defaults, the whole company goes down, which is what happened."
Both Fitzpatrick and Morrow strongly deny that the leveraged buyout had any deleterious effect on the mortgage unit. The debts were supposed to be serviced strictly by the title company and no pressure at all was placed on the mortgage company to perform more quickly, Morrow said. The parent company put an extra $19 million into TMIC soon after the buyout to improve its capital base.
"I don't think anybody could say that the company was weakened by any action we took," Morrow said.
In any event, American Can appears to have grown weary of its investment. A company spokesman said that the firm has no comment on the situation at Ticor, but earlier this fall American Can removed its four directors from Ticor's board.
Protecting Ticor title insurance company is now one of the top priorities for Morrow and his colleagues, who must bank on its profits alone to carry their investment in the short-run.
Ticor in September reorganized to separate the title and mortgage insurance operations, to make sure Ticor title can avoid damage from the mortgage insurance company's problems.
In the meantime, the situation at TMIC remains in doubt. The key is time. The longer the company can stave off paying the EPIC claims, the less the impact will be, because the company continues to take in investment income and make money on renewals of existing policies. Fitzpatrick and Morrow say they are much more optimistic than they were three months ago.
"In terms of resuming the primary mortgage insurance business, we don't see that happening in the forseeable future," said Fitzpatrick. But he added: "The company is still financially strong. . . . As we see the world turning today, the situation isn't nearly as grim as some people put it." CAPTION: Pictures 1 and 2, Two years ago, an investor group that included American Can's Gerald Tsai and ITT Chairman Harold S. Geneen raised $271 million buy Ticor.