LandAmerica Financial Group Q3 2007 Earnings Call Transcript

| About: LandAmerica Financial (LFGRQ)
This article is now exclusive for PRO subscribers.

LandAmerica Financial Group Inc.(LFG) Q3 2007 Earnings Call October 31, 2007 10:00 AM ET

Executives

Ted Chandler - Chairman and CEO

Bill Evans - CFO

Bob Sullivan, SVP of IR

Analysts

Nath Otis - KBW

Doug Mewhirter - Ferris, Baker Watts

David West - Davenport& Company

Tom Zeifang - Lucrum Capital

Jaime Lester - Soundpost

Michael Fomuk - Wolverine Asset Management

Su Ping Li - Tenor Capital Management

Nath Otis – KBW

Jonathan Captain - Captain Capital Management

Jay Kilmer - AberdeenFund Capital Management

Al Copersino - Madoff Investments

Tom VanBuskirk - McMahan Securities

Operator

Greetings, ladies and gentlemen and welcome to theLandAmerica Financial Group's Third Quarter 2007 results Conference Call. Atthis time all participants are in a listen-only mode. A briefquestion-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is nowmy pleasure to introduce your host, Bob Sullivan, Senior Vice President ofInvestor Relations for LandAmerica Financial Group. Thank you. Mr. BobSullivan, you may now begin.

Bob Sullivan

Thank you, Latania. Good morning and welcome toLandAmerica's conference call to review third quarter 2007 results. Joining me todayare Chairman and Chief Executive Officer Ted Chandler and Chief FinancialOfficer, Bill Evans.

Ted will open our call with an overview of third quarterresults and then turn it over to Bill for more details. Following that, we willopen the call for your questions.

The Company cautions listeners that any statements maderegarding the Company's future financial condition, results of operations andbusiness plans, operations, opportunities or prospects including any factors,which may affect future earnings are forward-looking statements made pursuantto the Safe Harbor provisions of the PrivateSecurities Litigation Reform Act of 1995.

Such forward-looking statements are based upon management'scurrent knowledge and assumptions about future events and involve risks anduncertainties that could cause actual results to differ materially fromanticipated results.

For a description of such risks and uncertainties, see thecompany's Annual Report on Form 10-K for the year ended December 31st, 2006,and other reports from time to time filed with or furnished to the Securitiesand Exchange Commission.

The company cautions investors not to place undue relianceon any forward-looking statements, as these statements speak only as of thedate when made. The company disclaims any duty to update any forward-lookingstatements made on this call.

Now, I would like to turn the call over to Ted Chandler.

Ted Chandler

Good morning, and thank you for joining us. Let's start bylooking at the overall operating environment to set the context for our thirdquarter performance. In our industry, 2007 will be known as the year whensummer never came. Traditionally, spring and summer are the time of the yearwhen we see an uptick in the residential market. Instead, in third quarter2007, total residential mortgage originations, as estimated by the MortgageBankers Association, decreased by approximately $147 billion or 21% from thecomparable period in 2006.

Purchase mortgage originations, which generate higher titlefees per order compared to refinanced transactions, decreased approximately 17%in the third quarter 2007 from the comparable period in 2006. Refinancings weredown 26% over the same time period. In particular, the industry is experiencingsignificant weakness in the western states of California,Nevada and Arizona, where our residential operationsare heavily concentrated.

[Lily’s] report that total mortgage originations in thesestates are down a collective 30% from third quarter 2006. In this very toughenvironment, our consolidated revenue in third quarter 2007 was $907 millionwith a net loss of $20.8 million, or a loss of $1.28 per diluted share. Thiscompares with $992 million of consolidated revenue and net income of $15.2million or $0.89 per diluted share in third quarter 2006.

Our commercial operations delivered another strongperformance in the quarter. Direct revenue from title and non-title commercialoperations was $126.5 million, an increase of 24.8% in third quarter 2007 overthird quarter 2006.

This performance reflects our superior service andexpertise, especially in closing highly sophisticated transactions, as well asa generally healthy overall economy, which drive commercial-related activity.Although quarter-over-quarter commercial results have been strong for a numbera quarters, these growth rates are not likely sustainable.

In this extraordinarily difficult operating environment, weare being aggressive in our actions to reduce cost. First, our seasonedoperators are urgently managing the group's cyclical downturn, by significantlyreducing full time equivalent or FTE’s and consolidating offices.

Second, we're making transformative changes to our coststructure, through our fusion initiatives. In August 2007, we announced aplanned reduction of 1,100 FTEs, during the second half of 2007, in theresidential and then the services groups, in related functions.

During the third quarter of 2007, we were ahead of thatplan, with FTE count reduced by 1,200 FTEs, in those two channels. During thefirst three quarters of 2007, we have eliminated 1,900 FTE’s or 20.6% of theFTEs in those functions as at the beginning of the year. On average, each FTEreduction is currently producing cost savings of approximately $73,000. InOctober, we have reduced an additional 500 FTEs, with more reductions ongoing.

We've reduced the number of offices during the quarter byapproximately 70. During the first three quarters of 2007, we consolidatedapproximately 125 or about 13% of our open offices at the beginning of theyear. The annualized rental expense savings from the office consolidations isapproximately $10.5 million.

As part of our transformation to a unified operatingcompany, we are also engaged in a number of fusion initiatives to maximize ouroperating efficiency and thereby improve return on equity.

Under production fusion we have consolidated 25 productioncenters this quarter. During the first three quarters of 2007, we haveconsolidated 35 production centers, with annualized rental expense savings of$1.8 million.

Technology fusion is our company-wise technology initiativeto reduce the complexity and cost of over 300 operating systems, to asubstantially reduced number of applications that will completely phase induring 2009. As of September 30, 2007 we've realized $7 million of the $35million in projected annualized cost savings.

A major factor affecting our results in the quarter was anincrease in the provision for policy and contract claims. The increase in theclaims provision ratio was primarily due to upward development of the 2005policy year and an increase in the initial claims rate for the 2007 policyyear, from 6% to 6.4%. On a title claims reserve liability to title claimedpaid basis, we maintain an industry conservative 5.5 accounts ratio.

We conducted our annual assessment of goodwill as of October1, 2007, reviewed by an independent evaluation firm and no impairment wasindicated. Our book value per share is $79.15.

During the third quarter 2007, we repurchased 919,500 sharesof our stock or $44.9 million at an average cost of $48.81 per share. Thisrepresents 5.5% of our outstanding shares as of June 30, 2007. This year, wehave invested nearly $127 million, repurchasing approximately 2 million sharesor 11% of total shares outstanding as of the beginning of the year. At ourcurrent per share price, we continue to view share repurchases as an attractiveuse of our excess cash on a risk-adjusted return basis.

In the regulatory arena, the California Commissioner ofInsurance agreed to propose substantial changes to the Information CollectionRegulation to simplify them, minimize compliance costs including delaying theeffective date by one year. Further, the Commissioner has committed toeliminate the interim rate reduction if the industry helped the CaliforniaDepartment of Insurance, obtained an affirmative method to infer theinformation collection, and eliminate the maximum rate formula if the industryworks with the Department to annex substantive alternate reforms. This is anencouraging development and we look forward to continue to work with theCommissioner to advance revolution. Now, I'd like to turn the call over to Billto review our financial results.

Bill Evans

Thank you, Ted. We reported a net loss in third quarter 2007of $20.8 million or $1.28 per-diluted-share, compared to a net income in thirdquarter 2006 of $15.2 million or $0.89 per-diluted-share. As Ted indicated,results for the third quarter 2007 reflected the sharp decline in residentialmortgage origination and an increase in the claims provision offset, in part,by strong results from our commercial operations.

In addition, we have some items that impacted thecomparability of operating income quarter-over-quarter, so I will summarizethose items before we move on to the segment results. During third quarter of2006, we completed the merger of Capital Title Group, which has been integratedinto the Title Operations and Lender Services segment as of the merger date,September 8, 2006. Our Capital Title results are fully reflected in the thirdquarter and first nine months of 2007. Capital Title results are only reflectedin the months of September for the third quarter and first nine months of 2006.

As of the end of third quarter 2007, we successfullyachieved annualized gross pre-tax cost savings of approximately $16 million inconjunction with the integration of Capital Title. With our integrationsefforts complete, this will be our final update.

In the first quarter of 2007, we incurred pre-tax incrementalseverance and lease termination costs of approximately $8 million, primarilyrelated to our previously announced cost-reduction program, and we also accrued$10 million for two class action lawsuits. Additionally, we receivedapproximately $12 million for the settlement from the Mercury lawsuit, which isreflected as a reduction of expenses.

Turning now to third quarter results, starting with ourlargest segment, operating revenue for Title Operations was $770.9 million in thethird quarter of 2007, a decrease of 10.9% from the third quarter of 2006.

This decrease was primarily due to further deterioration inthe residential real estate market and was offset, in part, by additionalrevenue from our merger with Capital Title and strong revenue from ourcommercial operations.

Direct orders opened a metric we use to determine therelative strength of future residential volume, and were approximately 233,200for third quarter 2007, compared to approximately 266,900 for third quarter2006, or a decrease of 12.6%.

Direct orders opened, slipped almost 20% from August toSeptember 2007. This decrease was primarily due to the fact that there are 19working days in September versus 23 working days in August. Orders closed inthe third quarter were only 57% of orders opened in the second quarter. Thisclosing ratio would typically be about 70%.

From a mix perspective agency revenue was 57.6% of the totaloperating revenue a decrease from 58.2% in last year's third quarter. Directrevenue was 42.4% of the total and represented an increase from 41.8% from theprior year's third quarter.

This mix shift was in part due to the inclusion of CapitalTitle, whose business is all direct.

Direct revenue from our Commercial Title operations was$103.1 million in third quarter 2007, compared to $85.7 million in thirdquarter of 2006, an increase of 28.3%. Although quarter-over-quarter resultsremained strong, this growth rate is likely not sustainable.

The claims provision, as a percentage of operating revenuefor Title Operations, was 9.9% in third quarter of 2007, compared to 8% inthird quarter of 2006. Each quarter we review our expected ultimate lossexposure, based on a number of factors, including our actual payment experienceversus the historical and expected experience of claims payment and makereserve adjustments as we deem necessary.

During third quarter of 2006, we saw upward developments forpolicy years 2001 through 2005. And during the second quarter of 2007 we sawupward developments in policy years 2004 through 2006. During third quarter2007, we experienced upward development mostly for the 2005 policy year. As aresult we have increased our expected ultimate loss ratio for the 2005 policyyear to 7%.

In addition, based on the challenging operating environment,which typically causes upward pressure on claims, we adjusted our expected lossratio for the 2007 policy year from 6% to a more conservative 6.4%, duringthird quarter 2007.

Personnel costs in the Title Operation’s segment were $222.1million in the third quarter 2007, a reduction of 5.2% from the third quarterof 2006.

One of the ways we are managing costs is through headcountreduction. In August, we committed to reducing headcount by 1,100 FTEs duringsecond half 2007. We have already exceeded this commitment by reducingheadcounts by 1,200 FTEs during the third quarter. Most of these reductions inheadcounts occurred in the residential and lender services groups, which arethe areas most affected by the decline in mortgage originations. The results ofour cost reduction efforts are showing in our results.

Compared to fourth quarter 2006, which included the resultof Capital Title for a whole quarter, personnel costs are down by an annualizedrate of about $260 million. In addition, because our recent actions occurredthrough outcome months of August and September, we expect to see additionalbenefits come through during fourth quarter 2007.

Also, as Ted mentioned, our FTE reductions have continuedinto the fourth quarter. Other expenses in the Title Operations increased 1.6%in the third quarter 2007 from third quarter 2006. Compared to fourth quarter2006, other expenses are down by an annualized run-rate of about $110 million.

The results of our cost reduction efforts are showing here aswell. Again, because the office consolidations occurred during the quarter, weexpect to see additional benefits in fourth quarter 2007.

Pretax earnings for Title Operations for third quarter 2007were $1.2 million, compared to $48.4 million for third quarter of 2006. Again,the compression in pre-tax earnings reflects the sharp decline in theresidential real estate market and the increase in our claims provision.

Turning to our Lender Services segment, operating revenuewas $67.3 million in third quarter 2007, compared to $59.6 million in thirdquarter of 2006, an increase of 12.9%. Improvement in the revenue was due toincremental business from the merger of Capital Title and growth in defaultmanagement services. These increases were offset in part by lower volumes incertain product lines in the loan servicing businesses and in the mortgageoriginations businesses, due to deterioration in the residential real estatemarket.

Personnel cost for lender services for third quarter 2007are showing an annualized run rate reduction of about $10 million compared tofourth quarter 2006.

In third quarter 2007, the lender services segment had a pre-taxloss of $2.7 million compared to pre-tax earnings of $3.4 million in thirdquarter 2006. The decrease in pre-tax earnings year-over-year was due to lowervolume in the mortgage origination business and increased cost associated withinvestments in technology.

Looking to the businesses within the corporate and othersegment, operating revenue increased by $6.4 million or $21.9% in third quarter2007 over third quarter 2006. This increase was mostly due to our commercialassessment and valuation operations, which have revenue of $23.4 million inthird quarter 2007, compared to $15.7 million in third quarter 2006, anincrease of 49%.

In addition, our financial services segment contributed $4million to pre-tax earnings in third quarter 2007.

Let's move now to some balance sheet and cash flowhighlights. Cash and investments were $1.5 billion, our claims reserve increasedto $862.2 million and shareholder's equity was approximately $1.3 billion. Bookvalue-per-share at the end of the quarter was $79.15.

In October 2007, we pre-paid all of our outstanding seniornotes Series B due in 2008, and all of our outstanding senior notes Series Cdue in 2011, by drawing down on our 2006 revolver. We exercise our options forprepaying the senior notes to enhance our financial flexibility, includinglowering our current interest rate by almost 200 basis-points.

At September 30, 2007 we have notes payable of $586.7million, of which $240 million is convertible into shares of our common stock.For the first nine months of 2007, we have generated $84 million of cash flowsfrom operations, compared to $122.9 million for the same period in 2006. Thisdecrease primarily reflects lower net income.

This concludes our prepared remarks, and at this time wewould like to open the call to your questions.

Question-and-AnswerSession

Operator

Thank you. Ladies and gentleman we will now be conducting aquestion-and-answer session. (Operator instructions). Our first question isfrom Nath Otis with KBW. Please state your question.

Nath Otis - KBW

Good morning gentlemen.

Ted Chandler

Hi Nath.

Bill Evans

Howdy Nath

Nath Otis - KBW

We obviously are ahead of your headcount reduction efforts,looks like you've done another 600 on top the 1100 you announced in August? Andthe market has been obviously worse, I think, than it was even in August, andat that point of time you also talked about where you alluded the possibilityof doing a comparable 1,100 reduction. Any thought on the possibility for afuture announcement of additional FTE reductions and may be why you didn'tinclude something like that this quarter in the press release?

Ted Chandler

Yeah Nath, this is Ted, as I mentioned in my remarks, duringthe month of October, we have reduced an additional 500 FTEs in residential andlender services group and related functions. When you add that to the 1,900FTEs from those two channels that we have already announced for the year thatbrings us to 2,400 FTEs reduced for the year on those segments. That's 26% ofthe FTEs and those functions from the start of the year. And we are continuingto adjust the cost to reflect the revenues that are available to us. It’s moreof an ongoing process, so that's why we gave you the additional color in ourcomments about what we've done this month on the reduction.

Nath Otis - KBW

I guess I would phrase it in a different way then. If itlooks like you are getting gains and to continue in a material way, do youthink you are going to make another announcement or could you make anotherannouncement like you did in August quarter with just a press release statingthe 1,100?

Ted Chandler

Well, our preference is to have our actions stand forthemselves and report as we accomplish these milestones. If your question goesmore to predicting the future as opposed to us taking the steps and reportingthem to our shareholders, we have a preference in not getting into a regimen ofmaking forward-looking statements. The statement I would make to you, and Ithink would hope that the listeners on this call would agree, is that, we aremaking very significant cost reductions to reflect the environment, and I mightgo a little further and say that because we took the step, we took earlier thisyear to organize ourselves under our customer channel structure, we havegreater clarity into the cost and the FTEs per channel, and I am very pleasedwith the actions that I experienced opportunities in adjusting those cost tothe revenue.

Nath Otis - KBW

Okay. Thank you. Just a next question, Lender Services, theother expenses in Lender Services seem to go up by almost $60 million thisyear, this quarter, sequentially, so I just wanted to see if there is any wayto get a little color on why expenses, other expenses would have gone up thatmuch in Lender Services in any type of cost and what we can look for, say inthe fourth quarter, will these things that might be one timer, or is thereanything like that would I think probably would be helpful?

Bill Evans

Okay, Nath, this is Bill. I'll see what I can do on that.There is some one-time items in there. We just talked about some investments intechnology, that's about a couple of million a quarter, that probably willcontinue. But we have been, as I think we've said several times this year,point is customer channel into a more cohesive organization. That does meansome restructuring FTEs and also closing this part of what's been going on inthe Lender Channel in addition to Residential. And we recognize that’s ourmanagement team there that we need to have an operation that is not generatinglosses and we are committed to achieving that.

Nath Otis - KBW

Alright. And okay. Just one last question and I'll get backin to the queue. Share buy-back; you bought back about $45 million thisquarter, which would seem to be ahead of your recent run rate in the $40million range. Is that something we can, maybe, look forward to continuing inthe fourth quarter, and just any color with -- your stock trading now below$30, any thoughts on any type of accelerated buyback right now?

Ted Chandler

Yeah, Nath, this is Ted. The way I would respond to that iswe continue to view share repurchases as an attractive use of our excesscapital on a risk adjusted return basis. And, so, we are continuing to takeadvantage of that opportunity. I don't want to predict -- make a forwardstatement as to how much we would be acquiring but the premise of your questionis certainly correct. We're buying back a lot more shares with the -- with ourdollars than we were in the third quarter, and of course, that figures into ourrisk adjusted return amount.

Nath Otis - KBW

Okay. Thank you. I'll just get back into the queue. Thankyou.

Operator

Our next question is from Doug Mewhirter from Ferris, BakerWatts. Please proceed with your question.

Doug Mewhirter -Ferris, Baker Watts

Hi, good morning. My first question deals with the claimsprovision in the quarter. If you do the math, it comes out to, including thecharge, it comes out to a little less than 10% of title premiums in thequarter, and if you back out the charge, it only does not set back down toabout 9%, which is, I guess, in the [PNC] road you would say that will be axingat your loss ratio. I know you work more on policy years, which -- and thatnumber is even not adjusting for the reserve charge, seems to be fairly highconsidering where you're pegging your policy year loss ratios. I was just wonderingwhere that other two points came from. Or is it just my math -- am I missingsomething around that?

Bill Evans

When you say the reserve charge, Doug what…?

Doug Mewhirter -Ferris, Baker Watts

Is it a higher claims provision of $5.5 million is what youput out in your press release?

Bill Evans

Okay.

Doug Mewhirter -Ferris, Baker Watts

I digged that out of your gross number?

Bill Evans

Now there the $5.5 million is just the difference betweenthe provision this year versus provision in the same quarter last year. Therewas upward development in third quarter of last year. If you look at theelements of what we put up, we went to a 6.4% initial estimate for 2007 duringthis quarter. Previously that has been 6%, so the catch up of 40 basis pointsfor the revenue in the first half was about $8 million.

And then we did have as I indicated upward development thisquarter mostly from just the 2005 policy year. And increased that to about 7%EBITDA ultimate expected loss ratio. So that really accounts for most of thebalance of the increase in the provision.

Doug Mewhirter -Ferris, Baker Watts

Okay. I just -- that was more of a change in the provision,a change in the charge, and I took that as a growth number for this charge. Isee. Bill if you look at -- regarding losses. Do you have any commentsregarding the correlation between the losses in Title insurance versus thecredit cycle. And it seem to be going in tandem. But if you just look at itfrom high point of view, may be some one from outside the industry would thinkthat the Title, the quality of the Title has less to do with the quality of the-- I guess the borrowers, that there seems to be a lot of questions around whythey seem to be so co-related?

Bill Evans

Yeah this Bill I’ll go ahead to take that one Doug.Typically in times of economic stress and economic stress can be a recession inthe economy. There can be problems in the credit market like we've seen. Peopleare looking for money to solve problems, some of what you see as in the claimsthat it might not have happened otherwise if you hadn't had a foreclosure oreconomic stress issue. Somehow its people attacking Title. It could prove to bea credulous attack, but we are required to come to the defense of our policyholders because we are required to pay the costs to defend our of coststrategy.

So, if we look back over the past 15 years our losses hadaveraged about 5.5%, and you can see in times of recession or other economicstress where they get higher than, that and in good times or years with veryheavy revives, they get lower than that.

Doug Mewhirter -Ferris, Baker Watts

Okay, thanks that was a very helpful answer. My lastquestion deals with the business mix and then I will hop back in the queue.When you made the purchase Capital Title, your business mix switched from theagency commissions or agency revenues in the high -- mid to high 50s down tobelow 50s. And now it seems to be moving back towards the mid to high 50s,which implies that Capital Title’s contribution is dropping way off towards orit's -- is that sort of a true statement or is -- have you perceived an unusualboost in agency business from where, from sources you haven't before and is57%, 58% more some more of the way we should be thinking about the mix goingforward?

Ted Chandler

Yeah. This is Ted. First of all that particular mix isbetween direct and agents. So in the direct side, you include commercial. Sowhen commercial is particularly strong it skews the direct number up, we willsay it in other way, it skews the agency number down. But to your point kind ofan underlying permit on Capital Title, in particular. Their geographicalconcentration and where the cost infrastructure for that franchise is locatedis in California, Arizonaand Nevada.And that geography is all disproportionate to the national averages is. Thenational average quarter-over-quarter is down 21% and that's based on NDAprojections, where those three states are up 30%. So apparently is true thatthe residential direct mix, as part of the Capital Title Group, which is nowfully inculcated into our western residential operation, is downdisproportionate to the country, but it is the industry, it’s the market asopposed to any other phenomenon.

Doug Mewhirter -Ferris, Baker Watts

Okay. Thanks. That's all my questions for now. I'll justdrop back in a queue.

Operator

Our next question is from David West with Davenport &Company. Please proceed with your question.

David West - Davenport & Company

Hi, good morning.

Ted Chandler

Hey, Dave.

Bill Evans

Good morning, Dave.

David West - Davenport & Company

I would wonder if you could a comment a little bitregarding, I guess debt levels as you – your current your debt to total cap isabout 32% then its normal range is, but as you pursue your buyback do youphilosophically feel like there is a certain amount of debt you need to reduceto keep that ratio in a certain range for the rating agencies?

Bill Evans

Yeah Dave, this is Bill. We typically said we like to managethat total cap to around 30% or a little bit north and I think we've said acouple of times this year that as we look at the aggressive share repurchasesand pulling the equity down that we may consider repayment or reducing the debtlevels. So we keep that as part of our continued evaluation of capitaldeployment.

David West - Davenport & Company

Okay, very good. And then as a kind of a follow-up to ourearlier question on the reserve development. You noted some of the activities,have you noticed any of the with adverse reserve development coming out of anyparticular geographies?

Bill Evans

No Dave, we've looked across geography, we've looked agencyversus direct, we've looked by loss type and there has been no change in theloss type, in other words does not have coming out of a particular fraud orforgery more than out of insertion exam, out of closing procedure. It's notcoming out of agency more than direct. We do have programs; we have a strongprogram with our -- within our agency channel to address the policies andprocedures and work habits to reduce future claims. And we also have effortsunderway in the residential channel to make corrections where we are notinghigher rates of our losses

David West - Davenport & Company

Very good. May be Ted for. I know that the residential sideobviously is tough environment right now, the commercial is holding up well foryou. You typically see a pretty good surge or a pretty good level of activityin Q4. Do you anticipate that right now at this point in time?

Ted Chandler

You are exactly right; the fourth quarter typically is astrong commercial quarter, particularly the end of that quarter as there is areal drive to get deals done before the end of the year. So that's a historicalpattern we would certainly expect that to continue.

David West - Davenport & Company

Great, okay. And I guess Bill one for you, I may have missedit, but in the press release I didn't see any note about any capital gains orlosses at the portfolio, was that pretty minimal?

Bill Evans

No, there were some capital gains in the portfolio. We haveactually had those gains fairly regularly throughout this year. Part ofmanaging a portfolio is to have not just coup on, but to have gains over time.That’s the total return concept. So, while they don’t show up with the sameamount each quarter, we do expect that to be a fairly routine part of ourreturn. And in fact on the page that tells you the entire income statement,Dave…

David West - Davenport & Company

Okay.

Bill Evans

That’s out of the $6.2 million in the quarter. And it was$6.1 million a year ago, so roughly comparable to a year ago.

David West - Davenport & Company

Alright. Thanks. I missed that. And then, there will belastly any general change in the investment philosophy there you kept thatportfolio pretty clean, over the years given all the, considering the sub-primeexposure, that kind of thing, any change there?

Ted Chandler

Not really, because we did not have any sub-prime or anysignificant sub-prime all day or CDO type exposure? That was pretty much theconforming, to the extent that we have mortgage-backed, it was the conformingand ready type of securities.

David West - Davenport & Company

Very good. Thanks so much.

Operator

Our next question is from Tom Zeifang with Lucrum Capital,please state your question.

Tom Zeifang - LucrumCapital

Good morning, guys.

Ted Chandler

Good morning.

Bill Evans

Good morning.

Tom Zeifang - LucrumCapital

Can you remind me what the goodwill was associated withCapital Title?

Bill Evans

Goodwill with Capital Title was a $130 million.

Tom Zeifang - LucrumCapital

$130 million? And none has been written off, correct?

Bill Evans

That’s correct.

Tom Zeifang - LucrumCapital

Okay. On the commercial side, could you give us a sense ofhow open orders were throughout the third quarter?

Bill Evans

We do not break the Open Order accounts down between thecommercial and residential. As we've indicated, commercial remained strong,steady, solid. Typically the fourth quarter is strong, but that typicallyhappens late in the fourth quarter so --

Tom Zeifang - LucrumCapital

So can you -- is there any way to say if commercial trendedin line with gross direct orders open?

Bill Evans

No. The gross direct is heavily residential. So commercialwould not have trended that sharply as the residential.

Tom Zeifang - LucrumCapital

And the lag between open and close, any difference oncommercial versus residential?

Bill Evans

Yeah. Residential is on a normal buy – sell; in a normalmarket residential is typically about a 60-day open to close.

Tom Zeifang - LucrumCapital

Okay.

Bill Evans

Commercial runs a very long range. You can have orders thatare open for months on some of the larger more complex transactions. So theopen order accounting commercial is not as relevant a major produce in theresidential.

Tom Zeifang - LucrumCapital

Okay. And some of the industry data is showing a dramaticfall off in commercial closing, would you comment on what you are seeing overjust the last -- since mid-August?

Ted Chandler

Yeah. This is Ted, every quarter I come in and state that,that the growth rate is unsustainable and that we are plateauing and sooner orlater I am going to be right.

Tom Zeifang - LucrumCapital

Let’s hope it’s not this quarter.

Ted Chandler

Yeah, again, if you look at the quarterly results, they areexcellent; the pipeline is good. I don’t think, that’s why I was careful in theprepared remarks, to say that the growth rate are clearly unsustainable, butgoing into the fourth quarter which is traditionally a good quarter, wecontinue to see our commercial services group performing well, and I would liketo give credit to the staff over there. They've particularly do great job withthe larger and more complex transactions and there was a nice pipeline of largecomplex transactions.

Tom Zeifang - LucrumCapital

And then would you comment on, there's been a lot oftheories out there about open versus closed orders, multiple applications. Isthere any truth that all of that is a lot of people that I see have a lot openbut very few closed?

Bill Evans

Yeah. Tom. This is Bill. My comment is that the closed ordercount in 3Q was only 57% of what was opened in 2Q.

Tom Zeifang - LucrumCapital

Okay.

Bill Evans

That normally you would see that at 70%. So that obviouslyis part of what put pressure on the results and the operations in 3Q. We arehearing that people are either opening loan applications with more of lendersto try to ensure that they get loan or that the transactions are canceling. SoI think there's a higher rate than normal and that will probably continue forsometime. So we are adjusting our typical timing models where instead ofexpecting 70% of orders to close or use a lower percent in trying to determineour stand.

Tom Zeifang - LucrumCapital

Okay. And then on the expense front. I was a little confusedabout what's going on October versus what your press release said. It is whatyou are saying in the press release compared to fourth quarter, has anythingchanged versus the 256 and the 80? I'm trying to get a fourth quarter run-rateoperating expenses. Is it just math of 336 buyback or…?

Bill Evans

No it would be a number higher than that because we did --the calculation that we did in the release took the full third quarter expensesand the fourth quarter of last year and we used fourth quarter because that wasthe first quarter that we had Capital Title in for a full quarter.

Tom Zeifang - LucrumCapital

Okay.

Bill Evans

And because the reduction; the FTE reductions, the officeclosures, the other things we were doing in the third quarter, what happenedthroughout the last quarter. The effect of those is not fully reflected in thethird quarter numbers.

Tom Zeifang - LucrumCapital

Yeah I understand now. But I'm trying to get anapple-to-apple for the Q4. Has anything changed in October to get the deltaversus Q4 '06 operating expenses?

Bill Evans

Yes, we are fully realizing all of the cuts that were put inplace from the third quarter and as we referenced we have an additional 500 FTEreductions in the month of October.

Tom Zeifang - LucrumCapital

SO it's the 336 plus 500 times I think you said 73.

Bill Evans

Yes,73 for the….

Tom Zeifang - LucrumCapital

For the full delta, the full annualized delta?

Ted Chandler

Well this is Ted. And we're doing more.

Tom Zeifang - LucrumCapital

Yeah. What I'm trying to get at is, are you guys cuttingexpense fast enough given what's going on the revenue side?

Ted Chandler

Yes.

Tom Zeifang - LucrumCapital

You believe you are…

Bill Evans

Yes, we do.

Tom Zeifang - LucrumCapital

Okay thank you.

Bill Evans

We didn't we would be going [bankrupt].

Operator

Our next question is from Jaime Lester from Soundpost.Please proceed with your question.

Jaime Lester -Soundpost

Hey guys. Just to get a sense on the share buy-back, thecurrent plan is to do another, you did $45 million in the last quarter and thenuse whatever's treed up from the re-domiciling in 2008 to mostly buyback stock.Is that still the plan?

Ted Chandler

Well we never stated that could be the plan. What we havestated is that we have a lot of financial flexibility because of the, becauseof the re-domestication. And we have the ability to dividend up, the original$235 million number of which $100 million has been dividend up. We have thefinancial flexibility as a holding company.

In our capital management what we’ve said, of course isthat, we continue to have our dividend and we have each year in the last numberof years increase that dividend. We see that as a very appropriate use ofcapital. We look at acquisitions and particularly in commercial and ininternational, we look for those opportunities and we did announce oneacquisition in that regards. And we continue to see the share repurchase as anattractive use of our capital on risk adjusted return. But we’ve never said howmuch we would spend in a quarter or predicted it.

I would go further to say though that when we announce theshare repurchase program, we have a history of executing effectively on that.And as of the beginning of this quarter, we had 106,000 shares left on ourshare repurchase program that was announced earlier in the year. And we have a1,500,000 share authorization from the board that we’ve announced in August. Sothat is the best statement of our capital management intensions with respect tothat managing flexibility.

Jaime Lester -Soundpost

Okay. But, I guess I would imagine that with stock at 35% ofbook that it would be tough to find an acquisition or it would be moreattractive than buying back stock, is that fair statement?

Ted Chandler

I think clearly that -- I think I said in my preparedremarks we find -- at these depressed prices we find the share repurchase to bea very attractive use of our capital so you are exactly right on that.

Jaime Lester -Soundpost

Okay. And then have you guys ever done any sort ofaccelerated share repurchase where you could, for instance, enter into ainvestment bank and buy significant amount of shares back at this level?

Ted Chandler

Well we have, when we talk with our shareholders and ongoingdialogue about their preferences, when I became the CEO and consistently sincethen we have a lot of two way conversations in which we ask our shareholderswhat is the best utilization of the capital, increase to ordinary income,dividends, single large cash dividend, share repurchases systematically andopportunistically, which is what we have opted for or a large scale sharerepurchase program. The best information and our best advices from ourshareholders and our own instinct lead us to conclude that this systematic andopportunistic share repurchase programs is more effective than going in withany kind of option process.

Jaime Lester -Soundpost

Right, but I would imagine that those opinions which arelisted on your stock is the higher level, so I would actually say that might besomething you might want to revisit. And just from my perspective of theshareholder, buying back 40% of your shares at once and leaving your market capwhat would roughly be one time, an average free cash flow of the past fiveyears. You either -- if you believe in the reserve levels and you believe thatthe book values is solid then it should be opportunity of life time, if you don’t I understand that, but ifyou do believe that the numbers you put out there are real then this I wouldalmost think it is your responsibility that accelerate the share repurchase.

And along those line is there any reason management hasn'tbeen buying shares, given how aggressively you are buying with the company’sowners?

Ted Chandler

Well. First of all, thank you for that input. Secondly, Ithink you would find that management is buying shares, and so is just kind of acontinuing program. I guess, you are saying that there hasn't been a big slashabout large purchases.

Jaime Lester -Soundpost

Well there haven’tbeen any open market purchases that have been reported at least in the sourcesthat I see, so?

Ted Chandler

Okay. Yeah, I would certainly say that where at these priceswe are buyers, not sellers.

Jaime Lester -Soundpost

I am glad to hear you are not sellers. Okay guys. Good luck.Thank you.

Ted Chandler

And thank you for that input.

Operator

Our next question is from Michael [Fomuk] from WolverineAsset Management. Please proceed with your question.

Michael Fomuk -Wolverine Asset Management

Hi. Thanks for taking the question. Back to the losses, youcharacterized in the times of normality around the 550 dip loss rate, and nowclearly it’s stressed, so it has jumped in – can you characterize part of thatis legitimate claims part is nuisance, what I will call nuisance? Can you giveme a little more color on how much of this might be legitimate versus nuisance,and how aggressively you fight a nuisance or do you just reserve based on, whatdo you think you need to pay on a nuisance basis?

Bill Evans

Any prior nuisance issues are reflected in the overallclaims experience. So when we look at payment pattern, that's taken intoaccount. I really don't have a good feel on how much of this is nuisance. Mostof the nuisance is in the expenses and over half of what we pay is for lossesthemselves. So that should give you some flavor. And, as far as, how long wefight the nuisance, as long as somebody is attacking are insured we have theobligation to defend them under the contract of the Title (inaudible)

Michael Fomuk -Wolverine Asset Management

Secondly, some of the, clearly some of the mortgage lendershave pulled back on how aggressive they are handing out money, and I justwondered if you might expect to see an inflection point on your book ofbusiness as a result of that too?

Bill Evans

When you say an inflection point you mean the --

Michael Fomuk -Wolverine Asset Management

For example, yeah, countrywide, you don't quote me on thepercentage here, but to say for example that may be 70% of the options normsthat might have qualified last year, would not qualify under the newunderwriting standards, and I just wondered if you would, as the new book ofbusiness rolls through clearly see a decline in the loss experience?

Bill Evans

Decline in the loss experience?

Michael Fomuk -Wolverine Asset Management

Yeah.

Bill Evans

No. I think once we get to a point of less economics stress,then typically you would see the loss provisioning come back to more of anormalized pattern.

Michael Fomuk -Wolverine Asset Management

Well, I'm not even talking about the point of less economicstress, assuming that home prices could decline in another 10% next year, butthe new business that flows through is of much higher quality, would you expectto see a lower experience?

Bill Evans

Yes. On policies that were written from that point forward,yes.

Michael Fomuk -Wolverine Asset Management

Okay. Thank you.

Operator

Our next question is from [Su PingLi] from Tenor Capital Management. Please proceed with your question.

Su Ping Li - TenorCapital Management

Hi. I have a couple of questions. One, can you just givedetails about how much cash do you have at the holding company level, and howmuch do you have at the subsidiary level and what's the capacity for you takedividend out from that subsidiary?

Bill Evans

Okay. This is Bill let me take care of that. At September30th, we had approximately $40 million of cash and short-term investments atthe holding company level and so far this year we've taken $100 million individends from our primary title insurance underwriters that leaves us with anadditional $137 million that would be available to us for the balance of thisyear if we took all of that .

Su Ping Li - TenorCapital Management

That's great.

And can you talk about the capital base at -- I assume youhave separate subsidiaries for commercial business versus...Hello?

Bill Evans

Yes, we are here.

Su Ping Li - TenorCapital Management

Hi. Versus residential as in your insurance business and doyou have different capital requirements, i.e. do you have higher capitalrequirements for the commercial business.

Bill Evans

We do not have separate legal entities for commercial versusresidential, we have separate channels. That's how we organize the company. Butthe residential agency and the commercial business are all written off ourthree primary underwriters. And the largest capital commitment is for thecommercial business, because of the size of those transactions.

Su Ping Li - TenorCapital Management

Okay. So you write commercial business from '03subsidiaries. I like - what I am trying to get into is, do you, because youhave higher capital requirements for the commercial business, would that reducethe capacity for you to take dividend out going forward.

Bill Evans

The dividend that I stated is available is based out of theearning lasts year as opposed to a capital requirement for commercial. Thedividends available in the future really will be covering the loss of thestatutory earnings for 2007.

Su Ping Li - TenorCapital Management

That's okay, that's helpful. Also I just wondered, for thecommercial title insurance, you said this will slow down. What's the current, Iguess operative, margin in that business? If the revenue declines, how muchcost can you cut in that business?

Bill Evans

We do not separately disclose the margins for commercialversus residential or agency. But there are costs that we can reduce incommercial should that the business turn down. We should aggressively reducethose costs as we've done with the rest of our channels.

Su Ping Li - TenorCapital Management

Would you say that you have more fixed cost in thecommercial underwriting business or it's not so?

Bill Evans

There might be slightly more but there's still a fair amountof variable costs within the commercial channel.

Su Ping Li - TenorCapital Management

I see, okay. My last question is, if you compare yourcurrent. I guess the most recent quarter, this quarter profitability comparedto -- in the last downturn 2000 -- 2001, how would you say your business isdifferent from in the past and what's the bottom of your profitability? Ifrevenue keeps going down what's the bottom here as to your profit or not?

Bill Evans

If you look at prior cycles 1999 and 2000 was an acceptablebottom, 1994 -1995 was a cyclical bottom. This is a harsher environment thateither of those two cycles and our operating margin, which is before the claimsline, is at or slightly above what we were able to manage to in those lessstringent to acquire two cycles. As for the other part of your comment, I thinkthat's a bit of a forward-looking statement of revenue continues to go down.And as Ted said we are prepared to manage the cost for whatever level ofbusiness happens to be available.

Su Ping Li - TenorCapital Management

Okay. But is there, I guess to the extend you can continuecut your cost, is there like a minimum revenue level you need to get for you toachieve profitability. Or you are saying that as well you can continue to cutcost either at a much lower revenue levels you can still get it?

Bill Evans

There clearly is some fixed cost levels that you have tohave in an organization and if revenue went below that then you would not beprofitable, but we are not prepared to give that number out on the call.

Su Ping Li - TenorCapital Management

I see, you. Okay. I have actually one last one, you said foryou to purchase more shares, so you want to keep the debt over total capitalratio around 30%, so as a result you have to look at your debt level and youmight have to retire some of the debt. I know you have to convert and assumingthat is revolver?

Bill Evans

We have convertible debt, we have a private placement, andwe have revolver.

Su Ping Li - TenorCapital Management

So when you say you might have to reduce some of the debt tokeep the debt ratio you are referring to the revolver or other type of debt aswell?

Bill Evans

The revolver would be the most flexible since that is ourshort-term debt.

Su Ping Li - TenorCapital Management

What's the rate and term?

Bill Evans

The revolver is in place and it basically functions as anyrevolver does, we can drill down and repay it as we choose the revolver is inplace for 2011 and it has a spread of over LIBOR I think about 60-65 basispoints.

Su Ping Li - TenorCapital Management

And that's just the holding company level not secured byanything?

Bill Evans

I'm sorry.

Su Ping Li - TenorCapital Management

That's just as a holding company that level not secured bysubsidiaries or anything?

Bill Evans

Yes, its holding company debt and it is unsecured, yes.

Su Ping Li - TenorCapital Management

Okay, that's great. Thank you so much.

Bill Evans

You're welcome.

Operator

Our next question's a follow-up question from Nath Otis withKBW. Please proceed with your question.

Nath Otis – KBW

Yeah. Just a couple of quick follow-ups. First of all; whencan you go back in the market to buyback your stock?

Ted Chandler

Nath, when we talk about – this is Ted, when we talk aboutsystematic repurchases, as well as opportunistic, the systematic part istrading plans, where we have a trading plan and we have a trading plan inplace. The opportunistic is where we have the ability during the open windowabove the trading plan to do transaction. So we have a trading plan in place.

Nath Otis – KBW

Okay but, so when does the open window -- when does thewindow open for the opportunistic?

Ted Chandler

We usually open it probably three days after our announcedearnings, which is this morning.

Nath Otis – KBW

Okay. And when is your next board meeting that you couldinconceivably, if you went through, both of your authorization when will be thenext point that you could ask the board for another authorization if necessary?

Ted Chandler

We can call a board meeting on 24 hours notice. Our nextscheduled board meeting is mid-December.

Nath Otis – KBW

Mid-December okay. And just last and just revisiting vendorservices again

Bill Evans

And I would just interrupt and to clarify too or to, I guessamplify, the share repurchase authorization in August was on a specially calledboard meeting.

Nath Otis – KBW

Okay. Thank you. That’s helpful. I guess, the last questionjust on back to Lender Services, we talked a little bit about the noise thatwas in the expenses, you know, obviously that business is impacted by reducedvolumes too, can you just give a quick overview of what type of expensesoutside of headcount could possibly come out of out of that business as volumesdrop?

Ted Chandler

Yeah. I’ll try to give you a little color on that, we’re, asI mentioned we’re consolidating offices, so we expect that our rent andoccupancy expense would come down in those operations. Some of the expenses youhave, like in the credit business you make, you buy credit information from thebureaus; that’s a variable cost that comes down as volumes come down. Officesupply is overnight and express packages, travel and entertainment, those wereall expense areas that we work on as well.

Nath Otis – KBW

Okay. Thank you.

Operator

Our next question is a follow-up question from DougMewhirter from Ferris Baker Watts. Please proceed with your question.

Doug Mewhirter -Ferris Baker Watts.

Just two quick follow-ups. The first, I missed your commenton operating cash flow, could you give that figure for the current and previousquarters again?

Bill Evans

Yeah, actually, Doug all I gave was a year-to-date operatingcash flow, which was$ 84 million.

Doug Mewhirter -Ferris Baker Watts.

Okay.

Bill Evans

Year-to-date.

Doug Mewhirter -Ferris, Baker Watts.

Okay. And on your cost cutting plans, do you have any kind ofgoals when you look at your cost structure to say, well in your Title business,for instance, where, you say well we want to be able to make a profit -- atleast breakeven without including investment income or to say in other words,our goal is to at least make a underwriting profit with your cost structure oris it a more complicated than that or is that not a relevant when you look at-- how you look at costs?

Ted Chandler

Well, this is Ted. I mean, we are very focused on our Returnon Equity, and so what we have is -- are we targets for each of the customerchannel? Obviously, in a quarter in which the business is all 21%, 30% in someof our most highly concentrated areas, you’re chasing the revenue down thehill, but when we look at how we are managing the business we manage it to growreturn on equity which we believe directly co-relates to improved shareholdervalue. So our capital management strategy and our operating strategy is incomplete alignment over improving our Return on Equity and that’s really themeasure that we use as we focus on our operating.

Doug Mewhirter -Ferris Baker Watts.

Okay. Thank you.

Operator

Our next question is from [Jonathan Captain from CaptainCapital Management]. Please proceed with your questions

Jonathan Captain -Captain Capital Management

Hi. I don’t want to be the dead horse here, but I am goingto -- I want to talk about two things and how they interrelate to each other,one is profitability and one is share repurchase. At this point, you’ve spent alot of money buying the stock all the way up to god knows where, and in thelatest quarter in the 40s, stock is at 28 right now, you know, you may have,first of all, I wanted to know, how much flexibility do you have to do a majorrepurchase right now? There are two options or something like that without running about the rating agencies and butthe other question really is not to push in that direction. I think it'simportant to look at the business now in terms of when its going to turnprofitable again. And given we are in an unprecedented housing market here anddoesn’t look like its going to happen overnight. How does that factor into yourdecision that went to go into the market and repurchase stock.

Ted Chandler

Well. This is Ted. And again we bought back 11.5% of ourissued and outstanding shares this year. We've a got a 1.5 million shareauthorization and we have treated those announced authorization as commitments.There are two parts to your question. One is the financial flexibility. We dohave a fair amount of financial flexibility because we have about $137 millionavailable for ordinary dividend up to the holding company. That gives us theopportunity to kind of reset our capital structure and as we have talked beforeand as you've seen from our actions at buyback of 11.5% of our issued andoutstanding shares, we've not been shy about executing on that.

The other part of your question was profitability. How doesfuture profitability impact on our current decision to buyback shares. Yes itdoes. Our future dividends from the regulated underwriters are key factors toour statutory profits that are earned in that. So we continued above ourcurrent flexibility point and our available dividends. The future dividendsbeyond that are quite dependent on the profitability of the business and ofcourse that's why we are taking this very aggressive cost reduction stance withrespect to that part of the business.

So they are interdependent with one another. And I heardfrom the earlier caller a suggestion that we consider a massive sharerepurchase and I thank them for those comments. Made a note of those and wewill be considering all kinds of opportunities to improve our shareholderreturn. So there's certainly an interdependence between those two, and we continueto manage our capital structure in a way that aims at improving our return onequity and ultimately the total shareholder return opportunity for the peopleon this call.

Jonathan Captain -Captain Capital Management

Okay thank you.

Operator

Our next question is from [Jay Kilmer with Aberdeen FundCapital Management]. Please proceed with your question.

Jay Kilmer - Aberdeen Fund CapitalManagement

Good morning. A couple of questions. The first is related toclaims. When you talked about the 5.5% average and how it moves higher instressful times. If we look at 2008 and if one assumes a higher level ofclosures versus 2007. I'd like to hear your view on where you think claimscould peak sometime in 2008. Will it be in the double-digit and should we wouldbe approaching 12%, 13%, 14%.

Bill Evans

This is Bill. Let me take a stab at that. Approaching 12%,13%, would be highly unusual. The only years that I think I've seen in the past20 of that high were the policy years out of the late 80s and that was createdby heavy commercial claims that were to fallout from the Tax Reform Act of 1986and extreme overbuilding in commercial. So that would be very surprising if theloss rates got that high.

Jay Kilmer - Aberdeen Fund CapitalManagement

And then secondly; on your cost structure, I am sure thatthere is probably a way to do this, given that you've been able to sort ofmaintain share in the residential business, but if you look at the end ofOctober and say you've taken out another 500 FTEs on October. What originationmarket are you sized for, if were to start-off, say November 1st and run 12months forward, in order to achieve profitability, what origination market doyou size for right now?

Bill Evans

Basically, we are sizing ourselves for the originationmarket that mortgage bankers is projecting for the balance of this year andnext year.

Jay Kilmer - Aberdeen Fund CapitalManagement

And what's the 2008 assumption?

Bill Evans

2008 assumption they've got it, I believe 1.9 trillion.

Jay Kilmer - Aberdeen Fund CapitalManagement

And you think that's a prudent level of where to structureyour business? Given the trends you see in September, and the only data point Iwill reference is, if you look at your September orders. And you made referenceto the fact your conversion rates were down from 70% down to 57%. If you lookat September, for example, in your open orders, your open orders or your openorders in the month of September were down 27%, but if you assume weakerconversion and use a 57% versus 70% that means that closed orders in Septembercould be down 40%.

Bill Evans

September, had only 19 working days, so the normal month has21 working days. You do have to normalize a month, because you typically get…

Jay Kilmer - Aberdeen Fund CapitalManagement

Well, so take the two working days out, and so say its 30%.So, just launching-off in September, forgetting about July and August, becausethings didn't tied until really mid-August. So thinking about September islaunching point, you are showing data points based on conversion and openorders where the business is tracking down potentially 30% plus and it doesn'tlook like your workforce reductions are tracking at that pace.

Bill Evans

You are down 30% from what point to what point?

Jay Kilmer - Aberdeen Fund CapitalManagement

No, I am taking. In September your open orders were 66,000,and in 2006 they were 91,000. If you just assume that those open orders aregoing to close at 57% versus 70% in the prior year, then your closed orders ofSeptember’s open orders will be down in excess of 30%, because you said yourconversions are low and you are assuming a more conservative conversion likegoing forward, based on your earlier comments.

Bill Evans

We feel we have been appropriately aggressive with thereductions in FTEs and if order counts soften from here we will take furtheraction.

Jay Kilmer - Aberdeen Fund CapitalManagement

And I guess the last question is how much flexibility, ifyou needed to do lets say the NDA number continues to come down and you need todo additional FTE reductions or the next trench of reductions as easy to do andcan you do them as quickly and forcefully as you have done the priorreductions? And if you could elaborate on that process.

Ted Chandler

Sure, this is Ted. None of this is easy, and to the extentthat it was relatively easy that was all done in the second quarter. The hardwork in the third quarter is really where we are restructuring operations. Alot of middle management there, we’ve changed our profits under managerstructure. That’s a reason why the guidance we’ve given you on the amount ofsavings per FTE has gone up. From a standpoint of how easy is it going forward,it is absolutely doable, but none of this is easy. I’m very pleased with thequality of the information that we get by channel, because we have greatvisibility now. We don’t have obscured result, as we might have in earlierperiods where commercial agency and residential was all jumbled up. And you canget [hefty] by local commercial orders, perhaps masking the fact that there wasa deeper decline in another one of our business segments. So, we’ll continue toreduce our costs to reflect the revenues. What is difficult is when it is goingat a time that it is going down 20%, 25%, 30%, you’re chasing revenue down ahill, and so the good work that is done to adjust your cost structure is notreflected during those periods of precipitous decline.

Once that stabilizes, at whatever level, we will be able tomanage our cost to improve Return on Equity and grow the shareholder value. Sowe don’t have an artificial floor below which we can’t go.

Jay Kilmer - Aberdeen Fund CapitalManagement

And the last question. Do you set a pretax -- do you have aninternal number like a pretax margin number that you set, that you say okay, wewant to try and get the business to X%, say 3% pretax margin, and wait for themarket to stabilize. How do you sort of say your FTE reduction numbers? Do youset it to breakeven profitability?

Ted Chandler

Now that’s too simplistic a model. We’re making strategicand tactical decisions all along the way. You are making judgments about…do youwant to exit a geography? Or are you able to do a hub-in-spoke design simplyconsolidate more of the offices. You accelerate the fusion initiatives whichare really going -- these are permanent cost advantages that we’ll have goingforward. So it is more complex. The United States real estate economy, as localas it is, and the way we as an industry set up our cost structure to advantageour industry of the opportunities is not -- does not lend to itself to simplegeneralizations. The key defense that we have -- is we have them is highquality experienced [operators] with excellent information about channel withthe will to adjust the cost to whatever the market reality, and that is what weare doing.

Jay Kilmer - Aberdeen Fund CapitalManagement

That's all I have. Thank you.

Ted Chandler

Thank you.

Operator

Our next question is from Al Copersino with MadoffInvestments. Please proceed with your question.

Al Copersino - MadoffInvestments

Hi, thanks very much. I have a couple, hopefully quick ones,as regards the reduction in the FTEs, I am assuming that there is, given thestate of the industry there is very little by way of voluntary attrition, youare not losing any people you want to keep, are you?

Ted Chandler

This is Ted. You always concern yourself a bit on unintendedconsequences, but the assumption in your question is that the choices that weare making is what’s leading to this decline and that answer is yes.

Al Copersino - MadoffInvestments

Okay. As part of the answer to this next question, you verywell -- misinformation that the comparison is not apples-to-apples, and if so,that would be helpful, but I am curious if you could remind us what the claimsratio reached to 94-95 and 99-2000 when it was more residential driven than thecommercial driven cycle of the late 80s?

Bill Evans

If you look at those development years, and I will talkabout development years as opposed to reported year. The years that developedupward tended to develop up to somewhere between a 6% and 6.5% type of ultimateexpected loss ratio.

Al Copersino - MadoffInvestments

Okay. This is hopefully a quick one. Would you mind verymuch if you could just give us the dollar amount that the '05 policy yourcharge was on a pre-tax basis?

Bill Evans

Let's see the upward development was about 60 or 70 basispoints, so if you apply that to 2005 revenue, it was about $3.8 billion in thatyear, so the map on that upward development is 60 to 70 basis points on $3.8billion.

Al Copersino - MadoffInvestments

Okay, great. And then my last question. You've talked aboutthis to a small extent today with regards to the debt to capital ratio andthings like that. I am curious if you could tell us what are the capitalrequirements that the rating agencies are most interested in? I don't know ifit's intangible capital or interest coverage ratio. What are some of thefactors that they most care about and where do you stand on these measures?

Bill Evans

They typically look at: number one, what are we doing withexpenses in the downward part of the cycle and I think we've demonstrated whatwe are doing there. And they look at both coverage and they look at debt tototal cap. They've been comfortable with us at the 30% debt to total cap. Ithink at 35% debt to total cap we would probably have a little differentconversation with them.

Al Copersino - MadoffInvestments

Okay. So those are the main measures. Okay, great. Thanksvery much.

Bill Evans

You are welcome.

Operator

Our last question is from Tom VanBuskirk from McMahanSecurities. Please proceed with your question.

Tom VanBuskirk -McMahan Securities

Hi, I just want you to go over, how the restrictions onupstreaming dividends work in the states that you're domiciled in now, as towhat are the requirements or what do you allow to dividend out versus profitsin the prior year and retained earnings and so forth?

Bill Evans

Our three primary underwriters which is where most of thecapital and earnings are, are all three domiciled in the State of Nebraska andthe general provision is that you are permitted to dividend either yourstatutory net income or 10% of your surplus, whichever is greater. So that’sthe basic rule that 10%. So as we've indicated we have an additional $137million that would be available to us over the balance of this year, should wetake all of that and then what's available next year will be driven off of 2007statutory earnings and/or as earnings surplus.

Tom VanBuskirk -McMahan Securities

Okay, so essentially this that $137 million that's in therenow essentially represents surplus?

Bill Evans

That is the amount of the surplus that would be available tous.

Tom VanBuskirk -McMahan Securities

Got it.

Bill Evans

This year.

Tom VanBuskirk -McMahan Securities

Okay. So the next year even if had subsidiaries that have astatutory loss for the year, you still have whatever surplus is in there as atthe end of the year, that could be there as they are?

Bill Evans

If you ran at breakeven or a loss the general rule would be10% of your spending statutory surplus.

Tom VanBuskirk -McMahan Securities

Okay, great. Thank you.

Ted Chandler

Okay, let’s wind it.

Operator

Okay now I'll return the floor back over to Bob for closing comments.

Bob Sullivan

Thank you, Latania. Iwill be available the next few minutes to take further questions. I am at804-267-8703. Thank you very much.

Operator

Ladies and gentlemen, this does conclude today'steleconference. You may disconnect your lines at this time. Thank you for yourparticipation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!