Fitch downgrades L&G

Fitch has downgraded Legal & General Assurance Society’s insurer financial strength rating to AA- from AA and assigned the firm a negative outlook.

The rating agency has also downgraded L&G’s long-term issuer default rating to A from A+ and the senior unsecured debt, issued by L&G Finance and guaranteed by L&G, to A- from A.

L&G’s subordinated debt rating has dropped to BBB+ from A- and the outlooks on the IFS and IDR are negative.

The downgrades reflect the volatility of L&G’s underlying earnings and higher leverage ratio compared to previous years. The negative outlook reflects the potential for further deterioration given L&G’s exposure to credit risk and bank hybrids and the uncertain economic climate.

Fitch believes L&G is still exposed to volatility in its earnings despite recent derisking of the balance sheet. Net profit, of which a key driver is returns from investment markets, declined to a loss of £1.13bn in 2008 from a profit of £718m in 2007 and profit of £1.63bn in 2006.

L&G is exposed to a further potential deterioration in the credit markets through its large corporate bond-backed annuity portfolio, Fitch says.

L&G has approximately £17bn of corporate bonds backing this business for which it holds an increased default reserve of £1.2bn. Fitch says this exposure is well diversified between sectors and geographies.

The exposure and default reserve are in line with peers on an absolute basis but, relative to the size of shareholder equity and L&G’s earnings, the exposure is higher than its peers.

The rating agency says, given the volatility of the earnings stream, L&G could have difficulty rebuilding capital in the event of the corporate bond sector deteriorating.

But, according to Fitch, offsetting these factors are L&G’s strong brand and franchise in the UK and its strong capital position, liquidity and operating cash generation.

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