Reliance Group Bonds Tumble

As Reliance Group Holdings Inc. stood teetering on the brink of ruin, its ability to resolve a legal dispute seemed central to the insurer's survival.

The $350 million market cap company already faced a long-slumbering stock price, higher-than-usual property claims and the prospect of refinancing $470 million of its debt in 2000 when Moody's Investors Service on Nov. 10 said it might cut the firm's bond ratings.

That news sent Reliance's $250 million of 9.75% subordinated notes tumbling to 46 and its $220 million of 9% senior bonds to 78 the following day. Subsequently, both issues rebounded slightly, with the subs up to 60 on the strength of "some speculation by vultures," a high yield analyst said.

Analysts said the bonds' trajectory was unclear. "It could go as high as 90 or as low as 20 - we just have to hold on and see," one high yield analyst said.

The vital element of Moody's potential downgrade was a protracted legal battle between Reliance and Unicover Managers Inc., a workers compensation insurance pool that left Reliance holding a bag of uncollectible reinsurance written by Unicover brokers.

In 1998, Reliance entered a fronting arrangement with Unicover under which Reliance reinsured policies, which were themselves then reinsured by Unicover. When Unicover's brokers filed arbitration seeking rescission of the policies, Reliance was left to answer for Unicover's debts.

And now, despite what one analyst called "blackmail by Unicover," Reliance has decided to seek an out-of-court settlement that, according to the company's most recent 10Q, could cost as much as $120 million.

Analysts said the company's ability to arrive at a quick and relatively inexpensive resolution of the Unicover litigation will either save or wreck Reliance's current A- rating with A.M. Best, the insurance company credit rater.

"If they don't get Best to reaffirm their A- rating, that's a drop from investment grade to non-investment grade," said KDP Financial Advisors fixed income analyst Gary Madia. "If they don't get that rating, I can't imagine they'd be able to raise the capital they need to raise in the coming months."

If the credit rating drops, the company becomes a snowball rolling toward distressed territory, analysts said. "They won't be able to write as many kinds of low-risk insurance, and they won't be able to raise more credit if they get the B-plus rating," said Brean Murray & Co. equity analyst Walter Fitzgerald. "They have a lot to accomplish, and if they don't accomplish it, they will be in a seriously distressed situation."

Should the company and its debt hit such rocks, analysts said there is plenty to sell to another insurer or financial institution. "I think their franchise is very solid," said Mike Schroeder, a high yield analyst at Wasmer, Schroeder & Co. "There are plenty of people out there, especially with the end of Glass Steagall, who would be interested in their assets."

And the company hinted earlier this month that it would entertain offers. It said in a press release that it had retained Donaldson, Lufkin & Jenrette and Bear Stearns to help it explore alternatives. Reliance also announced management changes aimed at allaying the Street's concerns. Most notable among the changes is a more active role for CEO Saul Steinberg, who will act as COO. Steinberg owns a 45% stake in the company.

But the analysts said several barriers stand between Reliance and any potential buyer, including the resolution of the Unicover litigation and the refinancing of most of the company's $700 million in total debt.

"There are too many variables at this point to predict a sale, but ultimately that's very reasonable," said Ferris Baker Watts equity analyst John Keefe.

All four of the analysts agreed that a buyer would have to pay a significant premium to Reliance's current stock price, although none of them named a specific takeout level.

"If Reliance can get a significant premium, they'd take a long look at an offer, but because of the softness of the insurance industry, I'm not sure there's anyone out there right now who would be interested," Fitzgerald said.

The company plans to attack its woes by settling with Unicover - a proposition that Schroeder said means "giving away the store now to avoid giving away more later"- by spinning off 20% of its Reliance Surety business in an IPO and by launching a Web site that would eliminate the need for agents.

"If they can do all that, and if they get affirmed by Best, that will alleviate the pressure," Madia said.

But, said Schroeder, "They have a very difficult challenge in front of them, and it's not clear they'll make it. I wouldn't count out the Steinbergs, though."