The Long and Short
CNA issues wide with room to tighten
Dan Bruzzo, CFA | May 19, 2023
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.
CNA Financial (CNA: Baa2/A-/BBB+) issued a new 10-year note on May 17 that priced very attractively relative to secondaries, particularly for a name with improving credit in recent quarters. The bonds continue to trade wide of issuance, offering a second opportunity for investors to increase exposure at levels attractive to the broader investment grade property and casualty segment. Even accounting for the much lower dollar price on CNA’s secondary bonds, the new issue looks likely to tighten.
The CNA 2.05%’30s trade in secondary at around $81.5, for example. If investors were to apply a highly conservative discount of approximately 1 full bp per $1 in secondary price to the new notes versus the curve, the estimated fair value on the new notes still appears that it would be landing in the range of 180 bp to 175 bp over the 10-year Treasury over time as market corrects itself.
CNA Financial New Issue:
CNA 5.50% 06/15/33 priced @ +200/10yr on 05/17/23, currently indicated wide of issuance at Bid/Ask +206/203
Issuer: CNA Financial Corp.
Amount Outstanding: $400 million
Make Whole +30
CNA is primarily a commercial property and casualty insurer, majority-owned by holding company Loews Corp (L: A3/A/A), and operating in the US, Canada and Europe, mostly via its Lloyd’s syndicate. The company is very well capitalized with a strong balance sheet and has been on an improving operating trajectory in recent quarters, despite some of the heightened catastrophe losses experienced by the industry. That catastrophe experience over recent years projects positive pricing momentum for the P&C industry over the near-term. In addition to traditional commercial lines, the company has material specialty operations, offering some good business line diversity. One of CNA’s biggest credit risks is its material exposure to long-term care (LTC), although the company continues manage down those risks as it gradually runs off that book of business over time.
CNA recorded impressive underwriting results in their recently posted quarterly earnings report earlier this month. The combined ratio (the all-in underwriting expense ratio relative to total revenue) was a successful 93.9% for the first quarter of 2023, even as the impact from catastrophe related losses increased to 2.4% from 1.0% in the prior year quarter. Excluding the impact of catastrophe losses ($52 million in first quarter) and development, the combined ratio improved to 90.8% from 91.4% in the first quarter of 2022 and about 40 bp from the previous quarter, which demonstrates management’s emphasis reining in expenses and improving overall profitability. Meanwhile, top-line gross and net written premiums increased 11% year over year to $2.72 billion and $2.25 billion, respectively.
CNA had its operating subsidiary insurance financial strength ratings (IFS: A2/A+/A+/A) affirmed by all four rating agencies that rate the company over the past year, and all agencies kept their outlooks at stable. Among the rationale cited for the affirmations was CNA’s earnings stability from improved underwriting performance, robust capital, and market-leading positions in commercial insurance as cited by S&P.
This week’s debt issuance by CNA helps to improve an already solid liquidity profile for the insurer by terming out its upcoming debt maturity schedule. Management will use a portion of the $400 million proceeds to fund the approaching $243 million maturity in November of this year. After that, CNA has a $550 million senior unsecured debt maturity due next year, for which the company could use the remaining portion of the proceeds to help pre-fund; although that does not rule out the prospect of another debt issuance between now and May of 2024. In their recent first-quarter earnings presentation, CNA estimates that they currently have $955 million in holding company liquidity available, which is down only slightly from the $1.04 billion as of year-end 2022. That total includes the entire $250 million available on their revolving credit facility through 2026, as well as the approximately $483 million in cash on the balance sheet.
Valuation of the relationship between CNA Financial and parent company Loews is often debated among active investors in the sector. The relationship has changed over time, reflecting various pressure points for the involved credits – namely CNA and the other material businesses held under the L umbrella, midstream MLP Boardwalk Pipeline Partners LP (BWP: Baa2/BBB-/BBB) and Oil & Gas driller Diamond Offshore (DO: Ca/NR), as well as the smaller Consolidated Container Company. All of the subsidiary debt, including CNA, is non-recourse to Loews. L typically trades tighter, though the relationship with CNA has gradually tightened over the past few years. The rating agencies view the standalone credit strength at the parent as an offset to the structural subordination of its debt obligations, relative to the assets and income streams at the various subsidiaries. Though there are no explicit guarantees in place, L implicitly lends support to the various subsidiaries. This was demonstrated in recent years when L helped form joint ventures to fund capital projects and has scaled back upstream distribution to enable the subsidiaries to improve balance sheets when necessary.
CNA is by far the largest component of the L conglomerate, representing about two thirds of the overall portfolio held, and the vast majority of dividend income streaming to the parent (hitting as high as 95% in recent years). CNA returns capital to the parent in the form of both ordinary and special dividends. Therefore, much of L’s operating risk profile resides with the P&C insurer. Furthermore, while L’s business diversity remains a critical asset and risk mitigate, volatile energy markets in past years have demonstrated the parent’s exposure commodity risk. Those risks do not flow through as directly to CNA – in part because it is supported by its own balance sheet and bondholders maintain priority on CNA assets, and also because the regulatory nature of the insurance industry makes it unlikely that the parent L would be able to raid its insurance subsidiary were it stressed for capital.