Montpelier Re Debt

The great Peter Schiff writes about how Montpelier Re debt is a compelling investment:

I’ll now discuss another investment I’ve made: Montpelier Re Holdings Ltd., a Bermuda-based writer of catastrophe reinsurance and property reinsurance. I like those lines of business and think conditions are favorable right now. But that’s not why I invested in the company. The company’s balance sheet is relatively conservative and liquid, which appeals to me. Assets total $2.8 billion, and liabilities, including $350 million of debt, total $1.44 billion. Shareholders equity is $1.35 billion. Net earned premiums were $528 million last year.

Montpelier’s stock, selling at 80% of book value, is attractive. But the company’s debt — specifically the 6.125% senior notes due Aug. 15, 2013 — is really cheap. The notes are trading around 74, a 14% yield to maturity.

The numbers are compelling. Montpelier could lose its entire $1.44 billion net worth (roughly half of its assets), and its bonds would still be money good. Last year, a bad year, Montpelier’s net worth declined by $300 million. And in 2005 (Hurricane Katrina), the company lost $750 million, almost as much as it had earned in the three previous years. In a good year, Montpelier can make $300 million or so. There’s no way to predict whether any year will be good or bad. Although it has never happened, the company could have a string of bad years in a row. I don’t think that’s likely, but it wouldn’t necessarily be a disaster for bondholders anyway. If Montpelier lost, say, three-quarters of its equity in one occurrence, it would have to shut down or raise new equity. Neither of those scenarios would impair bondholders, but they would be disastrous for shareholders.

The 14% yield on Montpelier’s short-term investment grade bonds is compelling. The bonds are priced for catastrophe even though none is apparent. Investing and underwriting are both about weighing risk versus reward. In the case of Montpelier’s bonds, the risk is moderate, but the reward is substantial.

Here’s a chart of the price of Montpelier bonds.

I’d like to look more into this, but I am hard-pressed for time nowadays.