The Long and Short
Alleghany still looks attractive
Dan Bruzzo, CFA | November 4, 2022
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.
Despite its recent acquisition by Berkshire Hathaway, Alleghany still trades at an attractive discount to its new parent. The closing of the deal on October 19 helped compress spreads between the debt of the parent and the new subsidiary. But the intermediate Alleghany notes still offer generous spread even after considering differences in dollar price. Berkshire will likely consider Alleghany as a core business and provide both implicit and explicit levels of support. That makes the Alleghany notes even more attractive.
Berkshire Hathaway (BRK: Aa2/AA/A+) initiated its acquisition of Alleghany (Y: A1/AA) in March of this year, something highlighted in May in Amherst Pierpont’s M&A Playbook. At that point, the discount was closer to 45 bp for a trade out of BRK 2030-2032 notes to the Y 2030s. The Y 3.625% 2030s still trade roughly 30 bp wide to the cluster of BRK maturities in that part of the curve, an attractive level.
Exhibit 1. BRK curve vs newly acquired Y debt issues
Y 3.625% 05/15/30 @ +133/10YR; G+123; 5.51%; $88.52
Issuer: Alleghany Corp (Y)
Amount outstanding: $500 million (Index-eligible)
Senior Debt Rating: A1/AA
Berkshire Hathaway Senior Debt Rating: Aa2/AA/A+
The $11.6 billion purchase of Y is BRK’s first big foray into the insurance space in a long time and the conglomerate’s largest scale acquisition in roughly six years. The original terms of the deal were accepted by both sides and a brief “go shop” period did not yield any competing offers. There were no apparent regulatory concerns raised during the approval process as well. BRK is legally assuming the existing debt of Y, but did not provide an explicit guarantee, nor did they dissolve the legacy debt ticker of the new operating subsidiary. BRK has a lengthy and storied track record of demonstrating financial support for the operating entities that fall under its conglomerate umbrella.
On the closing of the transaction, S&P equalized the ratings of Alleghany with those of the parent, raising the senior unsecured rating to ‘AA’ from ‘BBB+’ and assigning a stable outlook. The insurance financial strength (IFS) ratings of the operating subsidiaries at Y were also raised to ‘AA+’ from ‘A+’. S&P views Y as a core operation of BRK’s insurance group. In addition to the implicit support that the parent is likely to provide, the rating agency also highlights the explicit support that comes in the form of internal reinsurance agreements. S&P also believes that the existing external reinsurance agreements of Y could be replaced with additional internal support from National Indemnity or other group affiliates in the future.
Moody’s took a slightly different approach, raising the senior debt rating on Y to ‘A1’ from ‘Baa1’, and taking the insurance financial strength rating of TransRe to ‘Aa2’ from ‘A1’ and the IFS ratings of RSUI Indemnity and Landmark American Insurance to ‘Aa3’ from ‘A2’. Stable outlooks were assigned to all the ratings. Moody’s also acknowledged the high likelihood of both implicit and explicit support from the parent and highlighted that the IFS ratings of the insurance subsidiaries incorporate two notches of uplift from their standalone rating profiles. Both agencies appeared to compress the typical notching between the parent and IFS ratings (typically 3 notches) to reflect the broad support provided by Berkshire. Fitch does not rate standalone Alleghany.
Standalone Alleghany is a hybrid reinsurance and P&C operator, traditionally seen as a close operating comp to XL Group (XL: A3/BBB+/A-) and Arch Capital (ACGL: Baa1/A-/BBB+). Alleghany significantly expanded its reinsurance operations through the 2012 purchase of Transatlantic Holdings (TransRe) for $3.8 billion. Reinsurance and Excess & Surplus (E&S) are its two core business lines. The company’s risk profile is similar to that of a more traditional P&C operator with exposure to earnings volatility as a result of catastrophe losses. They are extremely well capitalized and a strong operator in their core markets. They had some modest Covid-19 related losses in 2020, but those exposures remain manageable.
Y has a very solid liquidity profile, which it helped improve through debt issuance in recent years – as proceeds were utilized to help term out its maturity profile. The Company has $942 million in cash and equivalents on the balance sheet as of the last quarter it reported standalone results, plus an additional $300 million available on their revolving credit facility through 2026. The next public debt maturity is not until 2030. Prior to that, there is just a small $85 million in loans outstanding in 2023, plus another $325 million in loans due in 2026. The remainder of Y’s debt maturities are in the long-end of the curve.