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How Will Scottish Re's Turbulent Year End?

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The full throttle, gun-the-engines rise of Scottish Re Group Ltd. over the past 3 years and its equally dramatic turn of fortune offer a cautionary reminder of the potential perils of unbridled fast growth, according to interviews and analyst reports.

For Scottish Re, the story may well have a happy ending, but analysts say a lot depends on what happens in the next few weeks. Analysts are cautiously optimistic that management put in place in early August will find a buyer for the Bermuda reinsurer and free up capital from its subsidiary.

In fact, a buyer could be announced within the next few weeks. In an Oct. 3 report, Bear Stearns analyst Saul Martinez observed that “based on past correspondence with CFO Dean Miller, the auction process appears to be in the second round.”

At press time, the company had not issued an announcement and had declined specific comment. Katherine Jones, a spokesperson, did note that company management is “actually acting on those [plans] and seeing milestones being reached.”

Hannover Re, Hannover, Germany, rumored to be a suitor, declined comment and SCOR, Paris, another rumored suitor, had not responded to a press request at deadline.

But for those maverick start-ups that may follow Scottish Re in the industry and even for established companies, the stomach-churning events the company and its stockholders have endured over the last months should give reason for pause. The company’s stock has ranged from a 52-week high of $25.99 to a low of $2.95 on July 31, following Scottish Re’s announcements that it would post an estimated net operating loss of $130 million for second quarter 2006, and the departure of its former CEO Scott Wilkomm. It closed at $10.46 on Oct. 17.

The company started its growth path at year-end 2001 when it acquired World-Wide Reassurance Company Limited and its parent World-Wide Holdings Limited from Pacific Life Insurance Company.

The Bermuda life reinsurer took the next big growth leap on July 7, 2003, when it initiated a public offering of 7 million shares “to support the growth of its business, to pursue new business opportunities in the reinsurance market.”

Three months later, on Oct. 24, 2003, the company announced it would acquire 95% of the outstanding capital stock of ERC Life Reinsurance Corporation for $151 million in cash.

The transaction, which closed on Dec. 22, 2003, was cited by rating agencies as a way to improve the company’s spread of mortality risk and increase its policy count to 7 million, from 2 million.

Almost a year to the day, on Oct. 18, 2004, Scottish Re announced its acquisition of the individual life reinsurance business of ING Re. Scottish received assets equal to reserves of $800 million plus a ceding commission of $560 million. For its part, Scottish raised $230 million in new capital to satisfy capital requirements for the new business.

But in January 2006, signs of a reversal of fortune began to surface. Andrew Kligerman, an analyst with UBS in New York, issued a report downgrading the company’s rating to ‘reduce’ from ‘neutral.’

The report noted that Scottish Re had missed analysts’ earning consensus for 4 of the last 5 quarters. It also noted that the company’s “risk profile seems to be rising with its recent acquisitions of large blocks, in which mortality results will likely deteriorate with further seasoning.”

Kligerman’s report expressed concern with the pricing of the ERC Life and ING Re acquisitions, stating that “we question whether the winner is really the loser in the 2 acquisitions…” The business from both transactions, the report said, would “likely account for about three-quarters of SCT’s 12/31/04 gross face amount in-force.” (On Oct. 2, 2006 Kligerman issued a report with a ‘neutral’ rating citing an improvement in liquidity.)

A period of quiet followed, but after the company’s July 31 announcement of its $130 million loss, Scottish Re’s ratings tumbled. In mid-August, Fitch Ratings downgraded the company’s issuer default rating to “BB” from “BBB-,” noting it was the third downgrade since the company’s July 31 announcement. It also downgraded the insurer financial strength rating of its operating units to “BBB” from “BBB+.”

Moody’s Investors Service downgraded the company’s senior unsecured debt to “Ba3″ from “Ba2″ and the insurance financial strength ratings of the company’s core insurance subsidiaries Scottish Annuity & Life Insurance Co. and Scottish Re U.S. Inc. to “Baa3″ from “Baa2.”

A.M. Best Co. dropped its issuer default rating on the parent to “BB” from “BBB-” and its insurer financial strength rating to “BBB” from “BBB+.”

And, Standard & Poor’s Corp. lowered the parent’s counterparty credit rating and continues to rate the parent “B+/Watch negative/–.”

In response, interim CEO Paul Goldean emphasized that the company’s units were “capitalized beyond minimum requirements” and also noted that “underlying business is sound” and “mortality experience remains in line with expectations.”

The company acknowledged in its second quarter filing that “short-term liquidity and collateral sources are tight.”

However, it recently announced steps that it maintains will help create liquidity. In September, the company said it planned to raise between $120 million and $250 million to reduce short-term liquidity pressures under a combination of reinsurance arrangements and credit facilities.

The statement was followed on Oct. 2 by an announcement that it had completed a reinsurance transaction that will provide additional liquidity of up to $120 million.

Additionally, it has reduced aggregate commitments to $42.8 million under a credit agreement dated July 14, 2005, among Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited, Scottish Re (U.S.) Inc. and Scottish Re Limited, and a syndicate of banks.

Scottish also terminated a $10 million letter of credit agreement on Sept. 22 that had been agreed to by Scottish Re (Dublin) Limited and Scottish Annuity & Life Insurance Company (Cayman) Ltd.

Rating agency analysts say that while these are positive steps, they need to actually see these steps completed before the rating agencies revisit Scottish Re’s ratings.

The most recent transaction does free up $120 million in capital, and the additional liquidity helps, says Keith Pieck, an analyst with Moody’s. The liquidity at the subsidiary level is sufficient, but the company’s cash position is still tight, he adds.

The company has notes that come due in December, and there is sufficient liquidity to meet those notes assuming there are no other liquidity needs, he continues. “They need to be purchased.”

They need to raise $200 million in cash in addition to the $120 million they just raised, Pieck says. Without a buyer or additional capital, he says there is the potential to run out of funds in first quarter 2007.

“The next 3-4 weeks will tell the story. It is critical to see how it [a sale] is executed.” In the absence of the sales process or additional capital, Moody’s will review the company’s rating for a possible downgrade, according to Pieck.

Martha Butler, an analyst with Fitch Ratings, Chicago, says that in the short term, management needs to terminate the $42.8 million LOC agreement so that the $120 million they just accessed can be moved from Scottish Annuity and Life Ins. Co. to the parent. This is a “key step toward resolving their most immediate issues.” They cannot currently move the money to the holding company because of the terms of a bank agreement, she adds.

It is similar to the $10 million Dublin LOC, but in the case of the Dublin facility, they had the LOC with themselves, Butler explains, so it was simpler to terminate.

There are still 2 months before the December obligation comes due, so there is time to get the money up to the parent, Butler continues. “If they indicate that they are dividending up, that would absolutely be a positive,” she says.

Butler says, “Their capital position is still in good shape and there is value here for a buyer.” But, she adds, “they need the sale to go through or the ratings could be somewhere else. They really need to be sold.”

Neil Strauss, an analyst with Standard & Poor’s Corp., New York, says S&P’s ratings will remain unchanged for the time being.

Although Scottish Re’s management is doing what it needs to do, until actions are actually completed, S&P will not take any action, he adds. “The pieces are potentially there, but action has to be taken.”

For many institutional investors, that action will be important. Although for the vast majority of these investors, Scottish Re stock is a small portion of their overall portfolio, some still have sizeable holdings.

Top mutual fund holders, according to SEC filings, company interviews and Yahoo Finance, include: Fidelity Balanced Fund with 1,936,100 shares; Fidelity Value Fund with 1,138,760 shares; Columbia Acorn Fund with 1,700,000 shares; Allianz Funds-NFJ Small Cap Value Fund with 929,400 shares; Hartford Smallcap Growth HLS Series with 835,000 shares; FMI Focus Fund with 542,700 shares; and Price (T. Rowe) Small-Cap Value Fund with 504,400 shares.

All holdings were for the period before the July 31 company announcement. Third quarter information is just becoming available at press time.


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