Annual results from Legal & General are out.
And everything is pretty much in line with expectations – which, isn’t saying much since expectations were pretty low to start with.
So, the final dividend has been chopped by 50 per cent, (the first divi cut in the company’s history), the IGD capital surplus has fallen (to £1.5bn, post dividend cost) and the group has posted an operating loss of £189m, which is slightly disappointing, according to analysts
On the plus side there is no capital raise but L&G is cutting back on new business to preserve cash.
We expect difficult economic and market conditions to continue. Going forward through 2009 we are taking a prudent approach to new business — ensuring that we balance our appetite with cashflow growth and balance sheet consolidation. We will be increasingly selective of the new business we write — targeting products with low capital strain, shorter payback periods and less risk to capital.
But more interesting is L&G’s decision to address market concerns over its “internally managed and constructed” CDOs.
Previously these had been classified within ABS, but no more.
Total Group holds collateralised debt obligations (CDO) with a market value of £1,004m. These holdings include £126m in traded CDOs and £34m exposure to an equity tranche of a bespoke CDO. The current market value of the equity tranche is approximately equal to the present value of future interest payable on the notes.
The balance of £844m relates to a further four CDOs that were constructed in 2007 and 2008 in accordance with terms specified by Legal & General. These CDOs mature in 2017 and 2018. The Group selects the reference portfolios underlying the CDOs to give exposure to globally diversified portfolios of investment grade corporate bonds.
L&G claims that it would take on average more than 40 per cent of the underlying portfolio to default over a 10-year period for any loss to occur.
The CDOs are termed as super senior since default losses on the reference portfolio have to exceed 28%, on average across the four CDOs, before the CDOs incur any default losses. Assuming an average recovery rate of 33%, then over 42% of the reference names would have to default before the CDOs incur any default losses. Beyond 28% of default losses on the reference portfolio, losses to the CDO would occur at a rate that is a multiple of the loss rate on the reference portfolio.
Losses are limited under the terms of the CDOs to assets and collateral invested. For illustration a £200m loss could be reached if default losses to the reference portfolios exceeded 32% or if 48% of the names in the diversified global investment grade portfolio defaulted, with an average 33% recovery rate. (All figures are averages across the four CDOs.)
As for the reaction from the analyst community, caution seems to be the key word.
Here’s Blair Stewart of Merrill Lynch.
Given the weight of concerns about the company’s capital position and asset side risks, we believe that the company will need to do a good job convincing investors that these issues are over-stated. Therefore all eyes will be on the analyst meeting at 9.30am today.
Related Links:
L&G slumps to a loss and halves dividend
Legal & General doubles defaults cover – FT.com
Fears over capital position hit L&G shares - FT.com