NU Online News Service, Aug. 5, 6:45 p.m. – Bad debt is probably not going to sink any U.S. life insurer any time soon, but investors should certainly be paying attention to the insurers’ bond holdings, according to a new report from Lehman Brothers, New York.
“Today’s balance-sheet irritant could become tomorrow’s gaping hole,” Lehman analysts Eric Berg and E. Stewart Johnson warn in the report.
Investors who buy bonds are lending money to the issuers. When money managers trade bonds on the secondary market, they factor in changes in the reputation of the borrowers, as well as changes in the interest rate environment, by adjusting the price from the initial face value, or “par value,” and adjusting the effective yield, or “yield to maturity,” from the stated rate.
The Lehman analysts define troubled bonds as issues that sell for less than half of par and trade at a yield to maturity of 18% or more.
The top 10 life insurance holders of troubled bonds controlled $4.6 billion of distressed debt March 31, which was equal to 2.4% of the 10 companies’ combined shareholder equity, the analysts write.
At the company on the top of the list, the value of troubled bond holdings amounted to 6.7% of March 31 shareholder equity, the analysts add.
The analysts estimate that, if all troubled bonds went into default and all payments stopped, the life insurer with the most default-sensitive earnings could see bond losses cut its 2002 earnings 7.5%.
The analysts describe the possible effects of widespread defaults as minimal, but they note that life insurers’ holdings might have changed since March 31, and they point out that their study looks only at bonds and other, similar debt securities, not at exposure to mortgages, real estate or collateralized debt obligations.