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Solid liquidity and attractive spread help mitigate risk in ProAssurance
admin | June 12, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
There have been 25 “fallen angels” year-to-date – credits that have dropped from investment grade to non-investment grade ratings territory, according to S&P. The rating agencies have taken a very proactive approach regarding the anticipated economic fallout due to the COVID-19 pandemic on IG credits. This environment puts additional pressure on low BBB and crossover-rated credits, which are most at risk of a potential move out of the IG Index. A look at ProAssurance Corp’s (PRA: Baa2*-/BBB-*-/BBB*-) only outstanding note – a front-end 2023 maturity (non-index) – indicates those investors are well compensated for the substantial risk of additional downgrades.
There have been a remarkably high number of downgrades of IG credits – over 120 year-to-date – with over 100 of those rating actions taking place since the third week in February (Exhibit 1).
Exhibit 1. Total Downgrades vs Upgrades (S&P)
Source: Bloomberg LP, Standard & Poor’s
PRA 5.3% 11/15/23 @ 350/3yr; G+347; 3.73%; $105.00
Issuer: ProAssurance Corp. (PRA)
CUSIP: 74267CAC0
Ratings: Baa2*-/BBB-*-/BBB*-
USD; $250 million outstanding (non-Index)
Exhibit 2. PRA ‘23s vs BBB/BBB rated Insurance Comps
Source: Amherst Pierpont Securities, Bloomberg/TRACE Indications
One of the most important considerations for these bonds is that PRA’s 2023 $250 million notes are the only current debt obligation in the capital structure; for which the Company has a $250 million undrawn credit facility that runs through 2024 and can be accessed to meet the obligation in the event of a liquidity shortfall. PRA also has a current cash balance in excess of $200 million as of 1Q20.
There are a lot of moving parts on the credit, including three ongoing reviews of the ratings (Baa2*-/BBB-*-/BBB*-), and a challenged business segment (medical liability insurance). Medical Liability Insurance has been facing numerous obstacles in recent quarters, which includes both highly competitive pricing and higher payouts to members. PRA was downgraded by AM Best recently reflecting these operational challenges. The stock sold off after reporting some poor developments in January. PRA is also facing some investor suits regarding a first quarter charge to increase reserves to cover its deteriorating loss experience.
The ratings reviews are in part due to the announcement of a recent acquisition of NORCAL Group for $450 million (which could increase to $600 million if reserves at the target develop favorably). It’s an all-cash transaction that they will fund with cash (they currently have $175 million + $3.4 billion in available investments) and with additional borrowings. In this instance, the issuance of new debt and resolution of the rating reviews could help bring some needed price discovery to the name, unless they choose to pursue private lending options. S&P stated last month that the recent earnings results put additional downside pressure on ratings. If they can manage to retain two IG ratings and commence a debt launch related to the acquisition, they could eventually see some significant price improvement on the existing non-Index notes.
The valuation looks very compelling even with all of the noise related to the name. There are not many other BB/BBB-rated comps to work from in the P&C Insurance segment. The Generic BB Financial fair value credit curve on the graph mostly represents a significantly higher risk category than regulated insurance companies (even with comparable ratings). Therefore, the downside risk to PRA bondholders in the event that the credit is unable to retain at least two IG ratings is likely less than the BB fair value curve that is depicted on the graph.
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