TEXT-S&P affirms Validus Re 'A', Validus Holdings 'BBB+' ratings
Overview -- Bermuda-based Validus Reinsurance Ltd. announced that it will acquire Flagstone Reinsurance Holdings S.A. -- We expect the company to experience relatively low integration risk due to short-tail reserves and limited integration of Flagstone's underwriting operations. -- We are affirming our 'A' financial strength rating on Validus Reinsurance Ltd. and 'BBB+' counterparty credit rating on Validus Holdings Ltd. The outlook remains stable. -- We believe the acquisition will boost Validus's capital base and property catastrophe premium writings, allowing the combined company to offer increased capacity. Rating Action On Aug. 30, 2012, Standard & Poor's Ratings Services affirmed its 'A' financial strength rating on Validus Reinsurance Ltd. (Validus Re) and its 'BBB+' counterparty credit rating on the holding company, Validus Holdings Ltd. (we refer to the two companies together as Validus). The outlook remains stable. Rationale On Aug. 30, 2012, Validus announced its acquisition of Flagstone Reinsurance Holdings S.A. for $2 cash and 0.1935 Validus common shares per Flagstone common share. Flagstone shareholders will own 12% of the combined entity. Validus has an agreement with Lightyear Capital and Trilantic Partners (collectively, 22.5% Flagstone common owners) that they will vote in favor of the transaction. Upon completion of the transaction, Validus expects to strengthen Flagstone's reserves by $76 million, take $59 million of other charges, and record a $58 million bargain purchase gain. It will discontinue Flagstone's noncatastrophe portfolio and migrate the property catastrophe book to, and optimized with, Validus's Bermuda business. The acquisition will boost Validus's capital base by almost $800 million with additional shareholder equity and Flagstones junior subordinated debt. Although Validus could potentially have the largest property catastrophe book in Bermuda, the overall business mix shift will be modest. We do not expect the acquisition to involve heavy integration of Flagstone's underwriting operations. This and Flagstone's short-tail reserves mitigate the integration risk of this deal. However, Flagstone's various legal entities in Luxembourg and Switzerland raise some concern around the fungibility of capital. Since beginning operations in 2006, Validus has shown strong operating performance with less volatility in underwriting performance than many peers. The company has also outperformed its peers in 2011, a year with substantial catastrophe losses around the globe. As a short-tail insurer and reinsurer with almost half of its premium writings in property-exposed business, Validus produced a combined ratio of 99.3% and a return on revenue (ROR) of 4.7% in a year when many reinsurance companies produced substantial underwriting losses. Validus has a strong competitive position within the property catastrophe and other short-tail lines of business, with $2.1 billion gross premiums written (GPW) in 2011. The group is well diversified in terms of reinsurance versus primary business, geographic spread, and specialized short-tail lines of business. Operating under two segments, Validus Re and Talbot, the company has a leading position in various lines of business and a presence in numerous global insurance hubs. The international noncatastrophe short-tail insurance writings and geographic diversification from Talbot balance Validus Re's more U.S.-concentrated property catastrophe writings. Validus Research enables Validus to provide scientific research to its cedants, helping solidify its competitive position. This service and the ability to offer sizable capacity help Validus maintain its position as an approved lead reinsurer for major cedants. Validus has also been able to capitalize three sidecars in the past couple of years, demonstrating its ability to bring solutions to market and further expand into the property catastrophe market without increasing its retained risk exposures. Outlook The outlook is stable. With Validus's expansion into emerging markets, we expect 2012 GPW to grow organically (excluding the effect of the proposed Flagstone acquisition), in the mid-single-digit range, mainly in the Talbot segment. Geographically, growth will be focused on Latin America and Asia through the company's offices in Miami, Singapore, and Santiago, Chile. As the company expands, we expect Validus's enterprise risk management (ERM) function will meet the additional complexity in the business. Over the longer term, we expect operating performance to remain strong with an average combined ratio of 80% to 85% (with catastrophe and other large losses contributing 25 to 35 percentage points) and an average ROR of at least 20%. Results will likely be volatile due to the company's severity exposures, particularly to U.S. windstorms. We also expect the company to maintain its strong capitalization. Considering the recent upgrade, an additional upgrade is unlikely over the next 24 months because of management's evolving corporate strategy and the potentially high volatility inherent in the company's risk profile. A negative rating action is possible if Validus doesn't meet our stated expectations, if its ERM capabilities fail to address the growing complexity, if it completes an acquisition that could compromise its risk profile, or if it experiences outlier losses in a significant catastrophe event that result in a loss of over one year of earnings or a 10% or greater loss of capital. Related Criteria And Research -- Evaluating Insurers' Competitive Positions, April 22, 2009 -- Analysis Of NonLife Insurance Operating Performance, April 22, 2009 Ratings List Ratings Affirmed Validus Holdings Ltd. Counterparty Credit Rating BBB+/Stable/-- Validus Reinsurance Ltd. Financial Strength Rating Local Currency A/Stable/-- Validus Holdings Ltd. Senior Unsecured BBB+ Preferred Stock BBB- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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