Shares of Aflac Inc. (AFL) touched their lowest level since
April 2000 Thursday after an analyst said the insurer's exposure to
hybrid securities issued by European banks, including Royal Bank of
Scotland Group PLC (RBS), is a "rapidly escalating concern."
Aflac shares fell as much as 39% in morning trading after Morgan
Stanley analyst Nigel Dally told the firm's clients to avoid
Aflac's stock owing to its $7.9 billion of exposure to securities
that have been sharply marked down after European financial firms
announced large losses this week. In early afternoon trading,
shares were still down 32.8%, to $24.38.
"If even a small portion of these losses are realized, the hit
to Aflac's capital ratios could be substantial, and their overall
capital adequacy could be significantly less than most investors
believe," he said.
Aflac disagreed. Laura Kane, an Aflac spokeswoman said Thursday
the company is "comfortable with our current capital position and
are constantly monitoring our investment portfolio," She said Aflac
will offer more "specific details" along with its earnings release
Feb. 2.
The growing trend toward government takeovers of banks, called
nationalization, calls into question the eventual status of the
so-called hybrid securities, bank-issued notes that have elements
of both equity and debt.
If the hybrid securities are classified as a form of equity
after a government takeover, "it would be akin to the creation of a
new toxic asset class," said Raymond James analyst Steven D.
Schwartz in an interview.
Although debt holders were largely "taken care of" after the
U.S. government stepped in last year to bail out U.S. mortgage
companies Freddie Mac (FRE) and Fannie Mae (FNM), equity holders
were not, Schwartz said. He said investors are worried that hybrid
securities holders in government-owned E.U. banks could face the
same fate.
The issue of whether these securities should be considered
equity or debt has already come up, said Kriss Cloninger, Aflac's
chief financial officer, in a December presentation at a Goldman
Sachs conference.
"And our hybrid securities, the bank capital notes basically,
all have an economic maturity date," Cloninger said. "And we had
always hung our hat on the fact that these should be accounted for
as debt instruments because they have an effective economic
maturity date that was in essence the same as the stated maturity
date."
In October, the Center on Audit Quality advised that unless a
security had a specific maturity date, it should be treated as
equity for determining when impairments on the value should be
recognized as being other than temporary in accounting statements,
Cloninger said. The Financial Accounting Standards Board is
currently considering the issue and has not made a decision.
Although the FASB's determination will affect accounting rules,
the debate underscores the unsettled definition of the securities,
which make up a substantial portion of Aflac's investments.
"Regarding the classification of hybrids, with the concurrence
of our auditors, we've carried them as debt instruments for 15
years, and we believe with good reason," Cloninger said in October,
during the company's third-quarter earnings conference call. "In
fact, had our auditors not agreed that they were debt instruments
for accounting purposes, we probably never would have bought
them."
Dally said the value of securities issued by Royal Bank of
Scotland, which said Monday its losses last year could be the
largest corporate losses in the history of the U.K., dropped as low
as 15 cents on the dollar this week, while similar securities
issued by other European banks have declined 30% or more to well
below 50 cents on the dollar in many cases.
About 80% of Aflac's $7.9 billion hybrid securities come from
European financial institutions including RBS, Dally said.
He estimated if Aflac was to take a hit from its exposure to
these securities of more than 15%, its capital ratio would decline
to a level where its credit ratings would be at risk and the
company might need to consider taking steps to raise more
capital.
Dally said Aflac's rationale for holding the securities was
based on the idea that the European banks would be viewed by the
governments as too large to fail.
"Faced with a distress scenario, Aflac believed the respective
governments would step in to provide support," he said.
So far, the U.K. has backed that idea up, injecting GBP37
billion ($51.3 billion) into RBS, HBOS PLC and Lloyds TSB Group
PLC.
But after RBS said Monday its loss during 2008 would be between
GBP22 billion and GBP28 billion, it became clear that the U.K.
government would have to commit more to prop up its failing banks,
and investors feared it would have to go so far as to nationalize
them.
Dally said Aflac's bet that the U.K. will backstop RBS and other
banks is risky, because if it and other banks are nationalized
outright, all classes of stock, including the preferred shares
Aflac holds, could be wiped out.
Just over $5 billion of the company's market value has been
wiped away so far Thursday.
-By Ed Welsch, Dow Jones Newswires; 201-938-5244;
edward.welsch@dowjones.com and Lavonne Kuykendall, Dow Jones
Newswires; (312) 750 4141; lavonne.kuykendall@dowjones.com
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