The Hartford 2011 Annual Report Download - page 209

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
F-74
15. Equity (continued)
Allianz SE Warrants
In connection with the Company’ s October 17, 2008 investment agreement with Allianz SE, Allianz was issued warrants, with an initial
term of seven years, to purchase the Company’ s Series B Non-Voting Contingent Convertible Preferred Stock and Series C Non-Voting
Contingent Convertible Preferred Stock, structured to entitle Allianz, upon receipt of necessary approvals, to purchase 69,115,324
shares of common stock at an initial exercise price of $25.32 per share.
The warrants were immediately exercisable, pending the receipt of specified regulatory approvals, for the Series B Preferred Stock,
which were initially convertible, in the aggregate, into 34,806,452 shares of common stock.
In addition to the receipt of specified regulatory approvals, the conversion into 34,308,872 shares of common stock of the Series C
Preferred Stock underlying certain of the warrants was subject to the approval of the Company’ s stockholders in accordance with
applicable regulations of the New York Stock Exchange. Under the investment agreement, the Company was obligated to pay a cash
payment to Allianz if such stockholder approval was not obtained at the first or second stockholder meetings to consider such approval.
Because the conversion of the Series C Preferred Stock was subject to stockholder approval and the related payment provision
represents a form of net cash settlement outside the Company’ s control, the warrants to purchase the Series C Preferred Stock and the
stockholder approval payment were recorded as a derivative liability at issuance.
On March 26, 2009, the Company’ s shareholders approved the conversion of the Series C Preferred Stock. As a result of this
shareholder approval, the Company was not obligated to pay Allianz any cash payment related to these warrants and therefore these
warrants no longer provide for any form of net cash settlement outside the Company’ s control. As such, the warrants to purchase the
Series C Preferred Stock were reclassified from other liabilities to equity at their fair value. As of March 26, 2009, the fair value of
these warrants was $93. For the year ended December 31, 2009, the Company recognized a gain of $70, representing the change in fair
value of the warrants through March 26, 2009.
The discretionary equity issuance program that the Company announced on June12, 2009 triggered an anti-dilution provision in the
investment agreement with Allianz, which resulted in an adjustment of the warrant exercise price to $25.25 from $25.32 and to the
number of shares that may be purchased to 69,314,987 from 69,115,324. The exercise price under the warrants is subject to adjustment
in certain circumstances.
The issuance of warrants to the U.S. Department of the Treasury triggered a contingency payment in the investment agreement related to
additional investors. Upon receipt of preliminary approval to participate in the Capital Purchase Program, The Hartford negotiated with
Allianz to modify the form of the contingency payment. The settlement of the contingency payment was negotiated to allow Allianz a
one-time extension of the exercise period of its outstanding warrants from seven to ten years and a $200 cash payment on October 15,
2009. The Hartford recorded a liability for the cash payment and an adjustment to additional paid-in capital for the warrant modification
resulting in a net realized capital loss of approximately $300 for the year ended December 31, 2009.
Additionally, the issuance of common and preferred stock during the first quarter of 2010 triggered an anti-dilution provision in
investment agreement with Allianz, which resulted in an adjustment to the warrant exercise price to $25.23 from $25.25 and to the
number of shares that may be purchased to 69,351,806 from 69,314,987.
The Company’s Participation in the Capital Purchase Program
On June 26, 2009, as part of the Capital Purchase Program (“CPP”) established by the U.S. Department of the Treasury (“Treasury”)
under the Emergency Economic Stabilization Act of 2008 (the “EESA”), the Company entered into a Private Placement Purchase
Agreement with Treasury pursuant to which the Company issued and sold to Treasury 3,400,000 shares of the Company’ s Fixed Rate
Cumulative Perpetual Preferred Stock, Series E, having a liquidation preference of $1,000 per share (the “Series E Preferred Stock”),
and a ten-year warrant to purchase up to 52,093,973 shares of the Company’ s common stock, par value $0.01 per share, at an exercise
price of $9.79 per share, for an aggregate purchase price of $3.4 billion.
Cumulative dividends on the Series E Preferred Stock accrued on the liquidation preference at a rate of 5% per annum. The Series E
Preferred Stock had no maturity date and ranked senior to the Company’ s common stock. The Series E Preferred Stock was non-voting.
Upon issuance, the fair values of the Series E Preferred Stock and the associated warrants were computed as if the instruments were
issued on a stand alone basis. The fair value of the Series E Preferred stock was estimated based on a five-year holding period and cash
flows discounted at a rate of 13% resulting in a fair value estimate of approximately $2.5 billion. The Company used a Black-Scholes
options pricing model including an adjustment for American-style options to estimate the fair value of the warrants, resulting in a stand
alone fair value of approximately $400. The most significant and unobservable assumption in this valuation was the Company’ s share
price volatility. The Company used a long-term realized volatility of the Company’ s stock of 62%. In addition, the Company assumed
a dividend yield of 1.72%.