Prudential Target AIA Comes With $7.37 Billion of Thai Sovereign-Debt Risk

Prudential Plc, the U.K. insurer buying AIA Group Ltd. for a record $35.5 billion, will take on $7.37 billion of Thai sovereign debt in the deal, as the Asian country’s deadliest political clashes in 20 years stoke investor concern about a possible default.

The Thai debt comprises almost half of the American International Group Inc. unit’s government-bond investments and 10 percent of its total portfolio, Prudential said in a regulatory filing. The London-based insurer, which plans a $21 billion rights offer to fund the deal, is also concerned that the Thai regulator will limit its growth plans in the country.

The cost of insuring Thai government debt against default is at the highest level in more than a year after at least 36 people were killed in anti-government riots in Bangkok. Chief Executive Officer Tidjane Thiam is already facing opposition to the AIA deal from some investors over the lack of information and price, and the holdings in Thailand, one of AIA’s top markets, may add to concern about the U.K. insurer’s strategy.

“Thailand may sort itself out, but it shows the kind of hidden risks Prudential is taking on,” said Paul Mumford, who helps manage 417 million pounds ($604 million) including Prudential shares at Cavendish Asset Management Ltd. AIA “gives the company a much bigger exposure if the Thai situation blows up. If it wanted to unwind that position, it’s so large that it couldn’t.”

Mumford plans to vote against the deal on June 7. Thiam must win the support of 75 percent of shareholders at the meeting to proceed with the record rights offer.

A Prudential spokesman wasn’t immediately able to comment.

Default Risk

Credit-default swaps on Thailand’s sovereign debt have surged 43.9 basis points since May 12 to 158.8, according to CMA DataVision prices. A basis point is 0.01 percentage point. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, and typically rise as investor confidence deteriorates.

The takeover of AIA would make Prudential the biggest life insurer in Thailand and six other Asian nations. Thailand has the second-largest embedded value within AIA, behind Hong Kong, at $4.4 billion. Embedded value is a measure insurers use to estimate the value of future payments from policyholders.

While Thailand is one of the 10 Asian insurance markets identified by Prudential to more than double in size within the next decade, growth may be hindered by tighter regulations, Prudential said in the filing. AIA’s business in Thailand, along with units in China and Malaysia, may suffer “an adverse effect” if regulators in those countries continue to increase ownership restrictions.

Doubling Profit

Thiam yesterday sought to win over investors by promising to double profit in Asia within three years and to extract $1 billion from AIA for investments and dividend growth.

The insurer had its rights offer delayed by 12 days after the U.K.’s Financial Services Authority asked the firm to hold more capital reserves to back its payouts to policyholders.

The regulator was concerned capital could get trapped in various Asian markets if global stock and bond prices collapsed, and Thailand is one of the countries with regulatory restrictions in place that could lead to that kind of scenario, Prudential said in its prospectus.

“AIA has historically been limited by regulators in Thailand on the extent to which it can distribute surplus capital from AIA Thailand to any other subsidiary or branch of the AIA Group,” Prudential said.

To contact the reporter on this story: Kevin Crowley in London at kcrowley1@bloomberg.net

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