Bancinsurance 3rd Quarter Earnings

This was not a typical filing. I'm going to separate this discussion into two parts, the operational side and the legal side.

Operationally, this quarter was a blast. The news reported premiums were down, but a closer look shows that they are writing more premiums than ever- they are just ceding more to their Producer-Owned Reinsurance Companies (PORC's).

Now, these ceded policies do earn a nicecommission:

During the three months ended September 30, 2007 and 2006, ceded reinsurance decreased commission expense incurred by $1,571,611 and $300,420, respectively, and $4,456,986 and $1,061,833 during the nine months ended September 30, 2007 and 2006, respectively.

Overall, earnings were boosted by a low tax rate and hurt by a realized loss on an investment, the effects of which approximately cancel each other out. But "normalized" earnings for the quarter of about $1.6 million was a big improvement. During the quarter the expense ratio dropped to 31.4% from 44.6%, which was one of the expectations in the original analysis. Meanwhile, book value per share increased to $39.4 million, and the stock is currently trading at a market capitalization of about $30 million. So on a pure-numbers we see this is definitely cheap.

Now, the legal front is where some uncertainty arises. With respect to the discontinued bond program, this statement from the last 10-Q was still present:

Highlands has provided loss information to the Company with respect to alleged losses for bail bonds issued in the State of New Jersey and for federal immigration bonds. Highlands has indicated in filings that it has additional exposure for bail bonds issued in states other than New Jersey. Highlands has not provided sufficient information for the Company to quantify these additional losses. As of September 30, 2007, the Company is reserving to its best estimate of future Highlands losses based on the most recent loss information received from Highlands with respect to immigration bonds and New Jersey bail bonds only.

Meanwhile, on a slightly more positive note:

In October 2006, the Company commenced arbitration against Ernst & Young LLP (“E&Y”), the Company’s former independent registered public accounting firm, in accordance with the terms of the engagement letter between the Company and E&Y. In the arbitration, the Company alleges that E&Y improperly withdrew the Company’s audit reports for the 2001 through 2003 fiscal years. The Company is seeking monetary damages in excess of $21 million. E&Y has counterclaimed, seeking to recover in excess of $475,000 from the Company for unpaid invoices and additional costs. An arbitration panel has been constituted and the hearing is currently scheduled for December 2007. The Company does not believe the ultimate resolution of this dispute will have a material adverse effect on our financial condition or liquidity. See Note 14 to the Condensed Consolidated Financial Statements for subsequent events related to the E&Y arbitration.

....

In connection with the Ernst & Young arbitration disclosed in Note 10, on November 12, 2007, the Company and Ernst & Young tentatively agreed to a settlement of this dispute whereby the Company would release its claims against Ernst & Young and Ernst & Young would agree to pay the Company $20,000 and forgive its counterclaim of $475,000. Upon execution of a settlement agreement, which is currently anticipated to be sometime during the fourth quarter of 2007, the Company would record a pre-tax gain of approximately $0.5 million related to the Ernst & Young settlement.

This was surely settled though just to save them both from a big legal battle. The sum being paid was very insignificant, so we can not assume any particular strength to Bancinsurance's claim. I mention this as important because the following was also new in this 10-Q:

On October 23, 2007, the Company and certain of its current officers (Chief Executive Officer, Chief Financial Officer and Vice President of Specialty Products) received a “Wells Notice” (the “Notice”) from the staff of the SEC indicating that the staff is considering recommending that the SEC bring a civil action against each of them for possible violations of the federal securities laws. The Notice provides the Company and each officer the opportunity to present their positions to the staff before the staff recommends whether any action should be taken by the SEC. The Company continues to cooperate fully with the SEC and intends to continue to do so in an effort to resolve this matter.

Pursuant to separate undertaking agreements dated November 12, 2007 between the Company and each officer who received the Notice, the Company has agreed to advance reasonable legal fees and expenses incurred by each officer in connection with the ongoing SEC investigation. The undertaking agreements require each officer to repay the amounts advanced if it is ultimately determined, in accordance with Article Five of the Company’s code of regulations, that the officer did not act in good faith or in a manner he reasonably believed to be in or not opposed to the best interests of the Company with respect to the matters covered by the SEC investigation. A copy of the form of the undertaking agreement is attached to this report as Exhibit 10.2 and the foregoing discussion is qualified in its entirety by reference to Exhibit 10.2. Under the Company’s code of regulations and Ohio law, the Company may also be required to indemnify each officer in connection with the SEC investigation.

That is something that I was hoping would not happen. You can read up more about Wells Notices (in general) here. We know from the 10-Q that this case "concerned the chronology, events and announcements relating to Ernst & Young LLP (“E&Y”), our former independent registered public accounting firm, withdrawing its audit reports for the years 2001 through 2003 for the Company." Finding out how costly this can be will be important in judging its ultimate impact. Overall, while the business showed improvement this quarter and valuations became more compelling, a new risk has also popped up with regards to this SEC matter.