Hallmark Financial ($HALL) — 3Q21 Update

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Hallmark is a specialty insurer and traditional P&C insurer in the Option bucket of my portfolio (it’s a small position with potential for big upside). A while back management had commented on separating the specialty business via IPO from the personal insurance lines which are breakeven/losing money.

Several quarters have gone by and no update on the IPO plans…

Meanwhile, Hallmark has exited some of the most troublesome lines of business and is sacrificing premium growth for increasing rates and improving profits…

The segment we care about (specialty) is very profitable and still performing well while the segments we don’t care about (standard commercial + personal) are losing money with only sporadic periods of profitability… I’d love to see management shut these down and exit these lines completely (instead of an IPO).

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Based on Q3 performance, a separation may not matter…

They earned a very legit $0.19/share ($0.76/share annualized) without any contribution from investment gains or one-time boosts… Loss expenses are starting to even out following the exit of troublesome lines of business!

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Book value per share is starting to even out and actually grow after taking a beating in 2020 from the exit of the binding primary auto business…

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So the stock is trading at 0.41x book value and 5x earnings (assuming Q3 annualized — very cheap, especially compared to specialty peers…

But there’s still the overhang from the money-losing standard commercial + personal lines and the potential for more losses from run-off lines (binding primary auto)… i.e. cheap for a reason…

Need to keep an eye on the losses from binding auto… The reinsurance contract tops out at $240m before losses start coming back to Hallmark. From the latest 10-Q:

As of September 30, 2021, the ultimate incurred losses from the subject business were $208.5 million or $32.4 million in excess of the Hallmark Insurers’ loss corridor.  Our reinsurance recoverables of $515.1 million include $49.0 million related to the LPT Contract as of September 30, 2021.

Another interesting area is the build-up of cash on the balance sheet lately… part of this could be to adequately handle any future reserves from the bad lines of business… but at the same time, this is creating a huge drag on earnings… through Q3 they’ve given up $2.5m or $0.14/share (pre-tax) in earnings from investment income! Are they planning to do something else with that cash pile??

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With “normal” underwriting income levels (i.e. Q3) and a more appropriate investment portfolio, it looks like earnings could be closer to $1/share annually… That would be a 10% ROE which would certainly help Hallmark trade closer to their long-run average of 0.8x book value (an $8 share price)…