S&P Revises Hartford’s Outlook to Negative; Debt/Hybrids Assigned Ratings

Standard & Poor’s Ratings Services has assigned its ‘BBB’ issue rating to Hartford Financial Services Group Inc.’s (HIG) proposed $1.1 billion senior debt offering. S&P assigned a ‘BB’ rating to HIG’s proposed $500 million mandatorily convertible preferred shares offering that are subordinate to existing junior subordinated notes. These securities qualify as “high equity content hybrids” under S&P’s classification because the “preferred shares mandatorily convert to equity within three years.”

S&P also affirmed its ratings on HIG and its subsidiaries and revised the outlook on all of these ratings to negative from stable. “The negative outlook on our ratings on HIG and its subsidiaries reflects our opinion that the improvement in HIG’s earnings is slower than previously expected due to impairments and realized losses on investments in excess of expectations for the ratings. We believe HIG’s modest prospective financial flexibility in the face of its ongoing sensitivity to equity markets, and investment results could converge to erode the company’s financial strength,” explained credit analyst Shellie Stoddard.

“The ratings affirmation reflects our opinion that HIG’s brand and franchise survived a tumultuous 2008 and 2009 intact. HIG has retained strong competitive positions in U.S. savings and retirement, group life and disability, and small and middle commercial and personal lines property/casualty markets. Meanwhile, it has exited certain institutional funding and international markets and repositioned itself in the U.S. retirement market with a lower-risk variable annuity offering,” she added.

S&P also noted that the operating earnings from these core businesses reflect a “strong underwriting performance and higher assets under management. However, increasing industry loss cost trends in the property/casualty sector could erode the strength of HIG’s operating earnings.”

The rating agency also pointed out that “net income is recovering more slowly than expected because of investment impairments and realized losses. Despite the incremental improvement in the company’s investment risk profile, we believe future losses in the investment portfolio will likely continue to slow improvement in HIG’s net income. The company has a high level of exposures to certain financial instruments, such as commercial mortgage-backed securities and certain troubled sectors (specifically financial services).”

The new debt and equity issues will “improve the quality of HIG’s capitalization by increasing its equity content,” said S&P. “HIG will use the net proceeds of these securities–plus existing funds and the net proceeds of the proposed new common equity shares–to repurchase in full the $3.4 billion preferred stock held by the U.S. Treasury Department (pursuant to its Capital Purchase Program participation) and to pre-fund $675 million in senior debt maturities in 2010 and 2011.

“Debt leverage should decrease dramatically to less than 25 percent of total capital from 32.5 percent at year-end 2009; financial leverage will fall to 33 percent from 39 percent at year-end 2009. The previously higher debt leverage reflected our treatment of the preferred shares the Treasury Department held. We treated these securities as debt because in our opinion, it was never management’s intent to keep them as a permanent part of HIG’s capital structure. GAAP interest and fixed-charge coverage are currently at the low end of expectations for the ratings but should improve as operating earnings continue to recover.”

But S&P also noted that “volatility of capital remains a threat due to ongoing stress in the credit markets, and exposure to equity market declines as they relate to variable annuity product guarantees. A dramatic drop in the equity market (the S&P 500 at 700) would create an additional $2 billion capital net of the benefits of HIG’s current hedging programs.

“HIG’s prospective financial flexibility, in our opinion, is a modest rating weakness. HIG’s unrestricted access to a long-term $500 million contingent capital facility is a source of prefunded hybrid equity. However, its $1.9 billion bank line of credit, which currently has favorable terms, matures in 2012. This approaching maturity limits HIG’s ability to use this source of funds to weather more than temporarily increased adversity.”

“We expect HIG to maintain its core business strength and conservative risk management practices. Core operating earnings will likely be stable over the next several quarters but lower than pre-2008 levels. Increasing loss cost trends in property/casualty operations may hamper future margin expansion,” Stoddard added.

In conclusion S&P said it is “not expected” that the ratings will be lowered. However they could be “if: Hartford’s competitive position weakens; Hartford adopts more aggressive competitive positioning to regain market share; the equity markets decline sharply; investment losses do not dissipate; business results deteriorate; or other economic pressures drive capitalization lower than expected.

“A return to a stable outlook would depend on enduring stable market conditions and diminished risk of asset losses, with sustained operating and improved net income, as well as sustained competitive advantages in multiple business segments.”

Source: Standard & Poor’s – www.standardandpoors.com