Lincoln National’s CRE exposure targeted by two hedge funds

By Carolina Mandl

NEW YORK (Reuters) – Two hedge funds have placed bets that bonds issued by life insurance company Lincoln National Corp (NYSE:) will fall or that its default risk will increase, due to their concerns about the company’s commercial real estate (CRE) exposure.

Investors have been on high alert for losses in CRE. That sector has faced challenges since the pandemic after hybrid working arrangements led to a sharp increase office vacancies. At the same time, higher interest rates made repaying debt more challenging.

In the past few months, Mill Hill Capital has taken short positions in Lincoln National’s credit, it said, while Saba Capital has held the firm’s credit default swaps, a derivative that offers investors protection against a default, a source familiar with the matter said. The source requested anonymity because the trades are not public.

Lincoln declined to provide comments on the hedge funds’ positions and referred to previous remarks by its management.

In May, CEO Ellen Cooper told analysts that Lincoln’s goal is to reduce leverage and boost capital. She added that the firm is “extremely comfortable” with its commercial mortgage loan portfolio and that any stress is “extremely manageable.”

In a recent presentation, the company said only 2.5% of its investment portfolio is in commercial mortgage loan portfolio related to office, adding the property prices are roughly double the mortgage amounts.

David Meneret, Chief Investment Officer at New York-based Mill Hill, is speculating that there could be losses in its CRE portfolio which he thinks could lead to a rating downgrade, making it more difficult for the firm to obtain new businesses and retain existing ones. He took the position in the second half of 2022 and has added more shorts since March.

Lincoln has an investment-grade rating by four agencies. Fitch and Moody’s (NYSE:) have a negative outlook. Moody’s did not respond to a Reuters request for comments. AM Best and S&P declined to comment on potential future rating actions.

Fitch Ratings’ senior director Jamie Tucker said in an email to Reuters the agency considers Lincoln’s CRE exposure modestly below-average compared with the industry, while the quality is materially stronger. He did not provide comments on the risk of a downgrade.

Mill Hill sees it differently. “The real challenge for the management team is how to navigate realized losses that will inevitably trickle in, especially with their CRE assets,” said Meneret.

In April, Boaz Weinstein, founder of New York-based Saba, said in a post the firm was holding some of Lincoln’s credit default swap (CDS), and had already sold some of it. The fund still holds a bearish position, a source said.

Lincoln’s CDS spread, a measure of credit risk, is 238 basis points, compared with 323 when Saba disclosed the position, meaning the perceived risk has declined.

A number of Lincoln’s bonds have recovered from the lowest levels reached amid the banking crisis in March.

Reuters could not determine if either fund made a profit.

SHORT SELLING

Some equity investors are also bearish on Lincoln. It is the second most shorted U.S.-listed life insurer, S3 Partners said, with 3.95% of its free float shorted, behind Citizens Inc, with 6.83%.

Year-to-date, shares are down 10%, although they gained 34% after Lincoln secured a deal on May 2 to transfer part of its universal life insurance and fixed annuity business portfolio to a reinsurer. It will increase its capital ratio by 15 percentage points.

Lincoln reported realized losses of $828 million in its last earnings, up roughly 20% from the previous quarter and compared to $181 million in gains a year earlier.

Insurers hold capital to cover potential losses. Among seven listed life insurers tracked by Barclays (LON:), Lincoln was the only one which ended the first quarter below its capital target.

Tracy Benguigui at Barclays said that in a recessionary scenario the company’s investments could be at risk of being downgraded which could hurt its capital, referring to Lincoln’s larger-than-peers’ investments in triple B rated bonds.

“LNC is at a critical juncture to rebuild capital,” she said in a note on May 11.