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June 16, 2010 Wednesday
Lincoln's TARP exit closes strange chapter in bailout
The Hartford Financial Services Group and Lincoln National spent less than a year in the Capital Purchase Program, but why the life insurers were included in the program remains an open question.
On Oct. 1, 2008, with Congress still struggling to find agreement on legislation that ultimately would create the Troubled Asset Relief Program, Senate Majority Leader Harry Reid, D-Nev., emerged from closed-door talks on the bill to deliver a warning to the press.
"One of the individuals in the caucus today talked about a major insurance company - a major insurance company, one with a name that everyone knows - that's on the verge of going bankrupt. That's what this is all about," Reid said. Ironically, in pushing for a bill designed to restore confidence in the financial system, Reid had set off a panic that sent shares of, among others, MetLife Inc., Prudential Financial Inc. and The Hartford Financial Services Group Inc. spiraling downward.
Two years later, the identity of the mystery troubled insurer still has never been revealed, presuming Reid did not simply make up the tale out of whole cloth. But with Lincoln National Corp. announcing June 14 that it would exit TARP's Capital Purchase Program - joining The Hartford, the only other insurer that took part in the CPP before completing its TARP repayment in March - it bears asking why the federal bailout was extended to the industry and what purpose it ultimately served.
For Lincoln, the decision to take the TARP funds does not seem to have had any major downside. Exiting the program just a year after it entered it, Lincoln is financing its exit by issuing $355 million of common stock and $750 million of senior notes. The insurer intends to use proceeds from the stock offering and $250 million from the notes, along with holding company cash, to pay back the $950 million it received from TARP. Another $500 million of debt would be devoted to financing the insurer's AXXX reserves for its universal life products.
The news has been greeted warmly, with Standard & Poor's Ratings Services upgrading the preliminary rating on Lincoln's preferred stock to BBB from BBB-, affirming the company's A- counterparty credit rating and affirming the AA- counterparty credit and financial strength ratings of its insurance operations.
Sell-side analysts have been similarly upbeat. Nigel Dally of Morgan Stanley noted that comparable TARP repayments have typically been accompanied by equity raises of 50% or more of the amount outstanding, while Lincoln's equity component will be closer to 35%. Dally wrote that while he believed Lincoln to be "very well positioned to repay TARP with only a minimal equity offering, there was uncertainty prior to the announcement of this offering as to whether this would be allowed by the various regulators."
"While there is no escaping that the recent market correction will have a negative impact on earnings, we still see the company as delivering a 10-11% return on equity, both for this year and in 2011. This level of return, in our view, should warrant a price to book multiple of 85-95% of book value," Dally wrote. "Looking 12-months out, we expect Lincoln's book value to stand at $40.25 a share. Using the mid-point of our fair valuation range, this brings us to a price target of $36, suggesting solid upside potential."
That also could be taken as good news for the U.S. Treasury Department, which continues to hold 13 million warrants to purchase Lincoln shares at $10.92 each. Given the company's June 15 closing price of $27.88, Treasury's profit easily could run into the hundreds of millions.
But TARP was not created to be a hedge fund. The relative ease with which Hartford and Lincoln have exited the program only makes it more puzzling why relatively cheap credit - funding that fellow life insurers Prudential Financial Inc., Allstate Corp., Ameriprise Financial Inc. and Principal Financial Group Inc. all turned down - should have been extended to these two firms in the first place.
To qualify for the CPP funds, both companies first had to convert to thrift holding companies, a change accomplished by Lincoln's January 2009 acquisition of Newton County Loan & Savings FSB, while The Hartford underwent a similar conversion with its June 2009 deal to acquire Florida-based Federal Trust Corp. However, the Jan. 30 report to Congress from TARP Special Inspector General Neil Barofsky noted that these investments "highlight an incongruity in the CPP program design," as the funds extended to the two insurers were based on the assets of their parent holding companies, not the thrifts they acquired.
"In the case of Lincoln, for example, the company was able to obtain $950 million in TARP funds after it acquired a thrift that, on its own, would have been able to obtain at most $350,000 (if it would have qualified for CPP funding at all)," Barofsky wrote. "Moreover, in using TARP funds, there was no requirement that TARP funding be used in connection with the subsidiary thrifts' activities. As it happened, the insurance companies reported that they used little (in the case of Hartford) or no (in the case of Lincoln) TARP funds in connection with the subsidiary thrifts' activities but rather used the vast bulk of the funds to support their insurance businesses."
The life insurance industry took a beating in 2008 and for much of 2009, both in diminished sales and eviscerated balance sheets. But outside of American International Group Inc., whose problems were and are too unique to be compared to the industry at large, it never faced a "run on the bank" situation. Its policyholder clients had ample surplus devoted to their claims and a comprehensive guaranty fund system to resolve any insolvencies. Like the identity of Sen. Reid's mystery insurer, the question of why the Treasury offered any life insurers a bailout is one whose answer may never be known.
June 22, 2010