Hartford: A Cheap Play on Distressed Debt

The S & P 500 is up about 32% from its March lows and spreads on corporate debt have come in strongly in the last few months. We're about to finally see the benefits of an improving market on the balance sheets of the insurers.

Hartford (HIG) has been singled out as a lame duck in the industry, ravaged by its large exposure to commercial mortgage backed securities (CMBS) and some other bad investments. This is a large company with many moving parts and I won't get into the effects of the market's move on its variable annuity business and the many other factors worth considering. I'm just going to take a quick look at what assets you're getting when you buy shares of HIG.

The firm said it had a book value of $7.9 Billion or $24/share or so as of March 31st, 2009. While pundits would have you believe that this is the number off of which you'll have to subtract the firm's credit write offs over the years to come, the opposite is more likely true. The book value before adjusting for unrealized losses is somewhere in the 40's per share. So remember that that $24/share figure reflects the market value of their portfolio at Mar 31st, meaning you can buy $24 of assets for only about $11/share at today's price - a good deal unless you think the assets are going to plummet much further. Better still, you get all its operating businesses thrown in for free.

It's also worth noting that the value of CMBS securities (as measured by the Market CMBS index) has risen substantially from the levels of Mar 31st as have the value of just about all of Hartford's supposedly toxic assets (such as bank preferred shares and debt). True, there will be some dilution from the government at about $9/share from the TARP deal but the next round of dilution from their deal with Allianz (AZ) won't happen unless the shares rise to at least $25 or so.

All in all, Hartford looks like a good leveraged play on the high yield debt markets at this point with a very strong risk reward ratio. It allows you to buy $1 of junk debt for less than 50% of the market price and you get the business for free. The funny thing is that the business itself is likely to generate substantial profits, also adding to the book value of the shares. Nobody wants to say it but if the markets continue to stabilise (as they have been), these shares are likely worth closer to $40 than $10. The risk everyone is worried about is that their $88 Billion portfolio takes further and deeper losses and wipes out the company's equity. Based on the underlying market performance of late, seems more likely we're going the other way.

Disclosure: Short Hartford puts, long calls.

Comments

[skwestorange:]

This article would have more credence if the author had put out breakdown of the 88 Billion of assets and an analysis of the same to support his thesis. Otherwise the article come across as author's wish and hope.

Jul 12 12:50 PM

[Trevor Phil...:]

You can find details about their portfolio of assets by going to their website and sifting through the quarterly presentations, etc. From memory, I believe they have between 1-3 billion of pref shares/tier 1 exposure. These securities have nearly doubled on average since their last quarterly. The largest component of the potfolio is corporate bonds (diversified), which have also improved in price. The elephant in the room is their 6 Billion or so of CMBS (10 billion at par value). They also have a couple billion of RMBS. Hope that helps you out.

Jul 13 11:13 AM

[Stone Fox C...:]

good report. HIG seems like to report good numbers tonight. Don't understand all the concerns that everybody has at this point.

Jul 29 02:55 PM