Zenith to the Junk-Bond Defense : Insurance: The firm’s chairman says its junk-bond investments and the junk market’s woes do not affect Zenith’s stability.
In the chorus of junk-bond critics, you won’t find Stanley R. Zax.
Zax likes junk bonds. Maybe it’s because his second cousin used to be in the junk-bond business. Perhaps you’ve heard of him: Michael Milken, who created the junk-bond empire at Drexel Burnham Lambert Inc.
Zax is chairman of Zenith National Insurance Corp., a Woodland Hills-based insurer that grew rapidly with the help of the high-risk, high-yield bonds, some of them issued by now defunct Drexel.
When Stephen Wynn, chairman of Golden Nugget Inc., needed $100 million a few years ago to build a hotel/casino in Atlantic City, N.J., it was Zax who introduced him to Milken. And Zax still defends junk bonds even though the junk-bond market has been pummeled by Drexel’s collapse, financial problems at several junk issuers and Milken’s indictment on securities and tax fraud charges.
Now junk bonds are causing problems even for Zax. In last year’s fourth quarter, Zenith National’s profit fell 43%, to $5.3 million, in part because Zenith suffered a $5-million loss on securities transactions that stemmed mainly from its sales of junk bonds. Zenith’s profit for all of 1989 fell 11%, to $41.1 million, on revenue of $483.9 million.
That caught the eyes of some short sellers--investors who try to profit from stocks that drop in price. They are betting the worst is yet to come because Zenith, which offers workers’ compensation insurance, other property/casualty coverage and life insurance, still has substantial junk holdings that have fallen in value.
As of Dec. 31, Zenith listed $161 million of junk bonds on its books, which equaled only 14% of its $1.18 billion in total assets but more than half of its net worth of $299 million. Zenith also had $34 million in low-grade, high-yield preferred stocks.
Zenith’s portfolio included junk bonds and preferred stocks issued by such struggling companies as Texas Air, Harcourt Brace Jovanovich, Weintraub Entertainment and MDC Holdings. Zenith also owns non-junk bonds and preferred stocks of such stalwart companies as Xerox, Tenneco, Texaco and CIGNA.
Concern about insurers holding junk bonds was heightened earlier this year when First Executive Corp., a big Los Angeles-based life insurer laden with junk bonds, suffered a huge setback because its junk bonds had plunged in value. Two weeks ago, it reported a $776-million loss for 1989.
Zenith itself on Dec. 31 estimated that the market value of its junk bonds was 15% below what Zenith paid for them, and Zax said its junk probably fell an additional 10% to 15% in this year’s first quarter.
“If they took those losses” by slashing the value of their junk bonds to reflect market prices, “the company would not have earnings for the next two years,” said Tim Davisson, a broker at Wheat First Securities in Baltimore who said he shorted 10,000 Zenith shares for his clients.
Neil L. Dolinsky, a partner at Dunnavan Dolinsky & Weeden Leuthold, a Minneapolis money-management firm that specializes in short selling, said he recently shorted 13,000 shares of Zenith’s stock.
“We think they will be required” to sell or mark down their junk in the future, Dolinsky said. When that happens, “it reduces your net worth, which reduces the amount of business you can write, which lowers your profitability.”
Zax, 52, rejected the possibility that any such thing will happen and contended that Zenith is one of the most conservatively managed insurers in the nation. He said that even if Zenith wrote off $50 million of its junk portfolio tomorrow, it would still have plenty of capital to support its current level of business. He said Zenith’s critics are forgetting that along with junk bonds, Zenith also has investment-grade bonds in its portfolio, strong operating earnings and adequate reserves against losses.
He acknowledged that if Zenith was required to sell or write down its junk bonds, “it would wipe out our earnings for a year.” But he added, “I don’t think it’s going to happen in any case, and I think it’s a ridiculous hypothetical. Nevertheless, I’m prepared to discuss ‘what-if’ scenarios.”
Some insurance analysts said they are wary of Zenith’s junk bonds, if only because the junk market’s problems could push Zenith’s stock lower. David Anthony, of Fox-Pitt Kelton Inc. in New York termed Zenith “an extremely well-run company” but said the stock is “very speculative.”
Zenith’s stock and those of other insurers took a drubbing in February after First Executive’s problems mounted, but otherwise the stock--which closed Monday at $16.75 a share on the New York Stock Exchange--is down only slightly on the year. (An active stock buyback program by Zenith has helped.)
Zenith’s biggest stockholder, with a 31% stake, is Reliance Holdings, the insurance holding company controlled by former raider and Drexel customer Saul Steinberg. Reliance tried unsuccessfully to sell its Zenith shares last year, but spokesman Brian Martin attributed the no-sale to “market conditions” and not to Zenith’s junk exposure.
Despite the warnings of Zenith’s critics, there is nothing on the regulatory horizon that would indicate Zenith will soon be ordered to do anything about its junk bonds. Insurers need not mark down their junk to market prices until they decide to sell the bonds or if the bonds’ issuer defaults. As long as an insurer plans to keep the bonds to maturity, they can keep valuing the bonds at cost.
The short sellers, noting that several of the companies that sold junk bonds are teetering, predicted that some issuers will not be around to pay up when the bonds mature.
The issue of insurers’ junk holdings spilled over from the savings-and-loan mess, where thrifts have been required to mark down their junk bonds. That’s because the S&Ls; are under regulatory orders to sell their junk within five years, which leaves them unable to hold the debt until maturity.
Junk bonds already were under pressure because some companies that issued them, especially those that were targets of junk-funded takeovers, are now struggling to keep up with their debts. They include Resorts International and Hillsborough Holdings--both now in Chapter 11 bankruptcy law proceedings--and Harcourt Brace Jovanovich, Eastern Airlines and Southland Corp.
But for California-based insurers, “there is nothing currently that would force someone to sell their junk bond holdings,” said state Assemblyman Patrick Johnston (D-Stockton), who chairs the Finance and Insurance Committee. However, Johnston has introduced a bill patterned after a New York law that would limit insurers’ junk holdings to 20% of their total assets.
Zenith is currently well below that limit, which is why “we would not have concern with them,” said Ray Bacon, the state Insurance Department’s chief deputy commissioner. Although junk bonds represent half of Zenith’s net worth, or capital, “from a financial solvency standpoint that relationship to capital doesn’t mean anything,” Bacon said.
Zax said if Zenith was forced to sell or write down its junk bonds, it would not reduce the amount of insurance it could write. State regulators allow insurers to write insurance generating roughly $3 of annual premiums for every $1 of its capital. Zenith is already well within that ratio, with premiums of about $413 million last year and $299 million of capital.
Zax also said that in addition to the $5 million Zenith lost from selling junk bonds in the fourth quarter, it likely lost about $500,000 in this year’s first quarter. But he said the above-average yields on junk bonds that Zenith owns more than offset any current losses or future defaults by junk issuers.
“We’ve had a few losses and I’m sure we’ll have a few more losses,” he said, but claimed that Zenith has earned $30 million to $40 million extra from junk bonds than it would have from other investments.
He also bragged that Zenith initially was a junk-bond issuer--it floated two issues totaling $135 million through Drexel--but that now its own bonds carry an investment-grade rating. Which is why, he said, “that it’s very distressing to see the problems that Drexel has had and the problems that my cousin has had.”
And his own problems? “I don’t perceive that we have any problems,” Zax said.
ZENITH NATIONAL’S HOLDINGS
Zenith National Insurance in Woodland Hills held junk bonds valued on its books at $161 million as of Dec. 31, equal to 14% of its assets and 54% of its net worth. The chart below is a partial list of the junk bonds and of holdings of preferred stocks of companies that were either major issuers or purchasers of junk bonds. The data were included in Zenith National’s annual report to the California Department of Insurance.
JUNK BONDS (in thousands)
Recent Issuer Cost market value* Trans World Airlines $11,756 $8,456 Wickes $2,373 $1,650 Maxxam Group $1,880 $1,880 MDC Holdings $802 $230 Weintraub Entertainment $700 $250
* Zenith National Insurance estimate as of 12/31/89
PREFERRED STOCKS
Recent Issuer Cost market value* Revlon Group $6,770 $5,640 First Executive $6,315 $5,340 Reliance Insurance $4,870 $5,376 Texas Air $2,328 $1,250 Harcourt Brace Jovanovich $1,330 $577
* Zenith National Insurance estimate as of 12/31/89
Source: Zenith National Insurance
