Insurance Debt

After the fully write down of CS Tier 1 notes In March 2023, and during the short turmoil in financial instruments that followed the unpleasant event and lasted for few months, I strongly suggested to find value in AT1 debt and in the Restricted Tier 1 bonds issued by Insurers in Europe. I explained in a previous note that to qualify as capital on the Solvency II balance sheet, RT1 instruments must meet the criteria such as those laid out in Article 71 of the Commission Delegated Regulation (EU) 2015/35. Due to their characteristics, a large part of the RT1s is rated investment grade, another reason for looking at those financial opportunities when credit risks and uncertainties prevail in the investors’ minds.

Insurers have managed well the high interest rate environment in 2022/2023 (an environment where they operate probably better…but this is a complex and not straightforward story), with strong attention to liability management exercise, and they used new compliant Tier 2 bonds to strengthen their credit profile and to call the securities with the call date falling in the second half of last year or in this beginning of 2024. But, as I highlighted many months ago, the Solvency II grandfathering deadline is getting closer- end of 2025- while the interest rates have corrected from the peaks seen in Q3 2023. Insurers will need to address properly their capital requirements because they can decide either to leave the current grandfathered bonds outstanding that will cease to be eligible for regulatory capital purposes, or to issue new RT1s, after a pause of more than two years since the strong credit markets of 2020 and 2021.

Issuing Tier 2 instruments proved efficient and easier than RT1s in times of stress, but I think today the Insurance sector made room again for the junior subordinated debt and the investors are finally ready to allocate money in the RT1 asset class which can offer high and compelling coupons when compared to the bonds issued between 2018 and 2021 (just an example, Allianz issued an RT1 bond in euro in September 2021 with a coupon of 2,6%, today quoted around 76) . While in my previous note I stressed the importance of buying at discount prices very selected and depressed grandfathered debt (not everything will be redeemed), with this note I raise the attention on the new wave of RT1s that should attract enormous and deserved interest despite the niche market and the “relatively unknown debt instrument” when it is compared to the more famous brother of AT1 segment issued by banks.

Credit considerations, technicals (liquidity for example, or docs), spread difference and relative value analysis between RT1s and Tier 2 (and I add the senior debt) and between RT1s vs AT1s, are in my opinion, valid points for looking at this stage of credit cycle at European insurers which refrained for two years from issuing this subordinated debt due to the high coupons that were required to meet the investors’ demand (in a context of a dislocated fixed income). The insurance sector did not need to issue expensive RT1 debt for the capital structure and/or for the investments realized on the asset side, although access to hybrid capital always remained an important element of insurers' financial strength, both under Solvency II and under any credit rating analysis. The corporate hybrids, a good product in my opinion and better than many HY notes, remain today less attractive than RT1s.

Fitch rating action in March 2024 (preannounced in January) on restricted Tier 1 debt, testifies the solidity of the asset class.

What we have seen this year? It is superfluous to say that all issues met widespread support from institutional fixed income investors with books covered several times and final prices well inside IPTs.

• AXA euro issue in January for 1.5 bio, coupon 6,375% (the name has more than 2 bio of notes that will lose the capital component in January 2026). This issue was really well received, easy to price and with identified comparables in the financial sector showing a fair coupon value. This bond quotes today at 104.5, for a 5,85% YTC. Maybe too compressed.
• NN Group, Dutch insurer, 750 million euro issue in March, coupon 6,375% (first ever RT1 for the Dutch Insurer for replacing an old bond issued in 2014. A refinancing effort as defined by the issuer). The bond came more than 60 bps inside IPT and roughly 5X oversubscribed.
• ASR Nederland 500 million euro issue at the end of March, coupon 6,625% (for funding a tender of an existing Tier 2 perp). This bond came, probably, too tight against comparables.

One important and final consideration: RT1s, similar to Tier 2 - where we have seen good and uninterrupted activity from different issuers - are a duration trade. The offered risk/reward ratio is superior against many high yield bonds recently appeared in the European market, but investors will need to have a view on the future direction of interest rates because the duration exposure is the double of what can be expected from a corporate BB or B issuer. I don’t see this feature as an element of concern with the ECB ready to cut the official rates in June; RT1s are an asset class with a tempting investment proposition and a market perform recommendation.

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