Last week, Fitch Ratings affirmed the debt and credit ratings of Lincoln National Corp. (LNC) along with a stable outlook. The ratings and outlook were based on the company’s steady improvement in liquidity and book value per share, a solid balance sheet and sustained growth fundamentals.
Accordingly, Fitch asserted its long-term issuer default rating (:IDR) of “A-” and insurer financial strength (:IFS) of “A+” on Lincoln and its subsidiaries. Besides, the short-term IDR remains intact at “F2”, while senior notes continue to be rated “BBB+”. Thus, all the ratings carry decently high positions in the Fitch rankings.
The latest ratings affirmation follows the cyclic review of Lincoln’s fundamentals, which paved the way for Fitch’s long-term optimistic outlook from the Fitch. In June last year, Fitch had revised its outlook on Lincoln's insurance subsidiaries to stable from negative, while affirming the financial strength of the company.
Reviewing Lincoln’s performance over the past year, the rating agency remains optimistic about the company’s long-term growth prospects. This is also validated by Lincoln’s adequate statutory capital of $7.6 billion at 2011-end, up 7.3% on year-over-year basis.
Healthy capital adequacy has also enhanced the company’s risk-based capital (RBC) ratio to 505% at 2011-end from 491% at 2010-end, which is also supported by the excess life reserves and variable annuity guarantees. Further, by securing a 5-year credit facility worth $2 billion in June 2011, Lincoln has established a long-term solution to finance its statutory reserves and shore up its life insurance operations, thereby attaining additional capital buffer.
Additionally, despite incurring consolidated asset impairments of about $750 million, with a net income of $294 million in full-year 2011, Lincoln fared decent well in 2011. The company continued a healthy pace of growth stride and reported net earnings of $245 million for the first quarter of 2012, although it came in lower than $314 million reported in the year-ago quarter. Overall, Lincoln remains well-capitalized by achieving expanded distribution relationships, improved deposits and net inflows, generating higher book value.
However, the rating agency remains concerned about the impact of the ongoing low interest rate environment, as Lincoln’s vast spread-based business is being adversely affected by the tightening of spreads. The company’s variable annuity business has an above-average exposure to the volatile equity markets, although Lincoln management practices disciplined hedging to minimize risk. Yet the economic volatility and competitive pressures restrict the desired investment income growth.
Moreover, Lincoln’s financial leverage of 31% at the end of March 2012 remains higher than Fitch’s estimate of 25% for the current ratings. While the increase was primarily due to the costs related to the accounting changes adopted by the company, another $300 million was raised through senior notes to pre-redeem a set of senior notes that were to expire in August 2012.
Nonetheless, Fitch believes that Lincoln has the capability to improve its financial leverage to range within 20–25% by embracing various strategies to reduce its debt and borrowing costs, thereby augmenting shareholders’ equity. The rating agency also expects the company to maintain its earnings before interest and tax (:EBIT) coverage to be within 8x–10x, in the long run.
Hence, barring some concerns, Fitch casts an optimistic long-view on Lincoln. The rating affirmation also validates the company’s disciplined capital management that helped the company weather the storm of the global economic downturn.
Additionally, it also aided in generating healthy earnings and growth from its core operations during the critical period that lasted over the last several quarters. Going ahead, enhanced liquidity and risk-adjusted capitalization will further boost the company’s competitive position against arch rivals such as Manulife Financial Corp. (MFC) and Genworth Financial (GNW).
As a result of its strong capital leverage, efficient debt restructuring and sound ratings, Lincoln is poised to consistently return incremental capital to its shareholders. Its comprehensive capital plan is also helping it to mitigate balance sheet risk and provide liquidity cushion to its long-term growth.
Lincoln carries a Zacks Rank #2, implying a short-term Buy rating. We currently have a long-term Neutral recommendation on the stock.
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