Some Insurers Can Raise Cash by Buying Back Hybrids... And Some Can't
Insurance companies such as XL Capital, Partner Re and Everest Re have been taking advantage of low valuations on their own hybrid securities -- debt securities with some stock-like features, such as trust preferred notes -- to buy them back through tender offers. But if buying back hybrids has recently been more attractive, it doesn't mean all insurers are in a position to take them out of the market.
Buying back hybrids makes sense. Insurers can lure investors with tender prices that are higher than trading prices but still well below face value, which allows insurers to book gains on transactions.
Insurance companies have been struggling during the current financial crisis, and beside for AIG, none of them have been bailed out or have received money from the government. So any ways they can raise much-needed cash -- and buying back hybrids is one -- is highly sought after. Just look at the following numbers:
- Last month, Partner Re repurchased roughly 75 percent of a $250 million hybrid note offer at an exchange price of $500, including accrued interest. That price represented a $13 premium to the market price, according to figures compiled by Barclays Capital in a recent research note (not available online). Yet it was still only half the face value of the notes, allowing the insurer to book an $88.2 million pretax gain in its first quarter earnings.
- Similarly, XL Capital said that its own tender offer, which closed in late March, will allow the company to book a $211.8 million pretax gain in 2009 first-quarter earnings.
The main one is that the hybrids contain no "replacement capital covenants," which are clauses that stipulate that the buyer must replace the hybrids it purchases with securities that feature similar hybrid characteristics.
For instance, insurers like Travelers Companies and StanCorp Financial Group have hybrids with replacement capital covenants, which limits their flexibility. It doesn't mean these insurers can't issue equity to replace their hybrids: Aspen Insurance, for instance, did so late last month. But transactions such as Aspen's can make an exchange too expensive if there's a need to issue additional hybrids, and can dilute an insurer's stock if the insurer decides to issue shares to replace hybrids. (Banks' hybrids are also trading below face value, which could allow banks to buy them back. But many banks like Citigroup are also short on cash and have instead exchanged hybrids for equity.)
Property and casualty insurers Axis Capital Holdings, White Mountain Re Group and Zurich Financial Services have more flexibility to buy back hybrids, since their securities have limited or no replacement capital covenant in their securities.
Even without replacement capital covenants, some insurers may still face trouble buying back hybrids, since they also need enough cash for the purchases. Large insurers like Hartford Financial Services or Prudential Financial, for instance, could have trouble with hybrid repurchases given their own recent financial worries.