EU Rules May Increase Appeal of Insurer Subordinated Bonds

EU Rules May Increase Appeal of Insurers’ Subordinated Bonds
The price of Paris-based Axa’s 1 billion-euro ($1.37 billion) subordinated bond sold in 2006 fell to 71 cents on the euro from 89 cents since the end of June. Photographer: Antoine Antoniol/Bloomberg

European insurers, including Axa SA and Allianz SE, may redeem subordinated bonds depressed by the region’s debt crisis because they won’t qualify as core capital under rules being introduced in 2013, investors say.

The price of Paris-based Axa’s 1 billion-euro ($1.38 billion) subordinated bond sold in 2006 fell to 71 cents on the euro from 89 cents since the end of June. That makes this type of debt an attractive investment, said Daniel Grieger, a partner at Zurich-based Twelve Capital AG, adding that European insurers have about 85 billion euros of such bonds outstanding.

“Most insurers will redeem their callable subordinated bonds as they won’t qualify as core capital under the new regulation,” said Grieger, who manages 100 million euros of the notes. “Future redemption at par value offers a great opportunity at current prices.”

The European Union will introduce Solvency II rules from 2013 in a bid to align insurers’ risks with capital to offer more protection to policyholders. There may be a transition period for bonds that won’t count as core capital under the new regulations. Some notes sold by insurers such as Axa and Assicurazioni Generali SpA have slumped amid concern over holdings of debt from peripheral EU countries.

“The market has once again over-estimated risk,” Rafael Villarreal, a credit analyst at BNP Paribas SA, wrote in a note to clients dated Oct. 7. “This mispricing of risk creates opportunities.”

‘Cherry-Picking Time’

The debt crisis has created uncertainty that has pushed up yields on subordinated bonds issued by insurers to an average of about 15 percent over the past few months, said Narciso Quijano, head of fixed income investments at Munich-based BayernInvest.

“All subordinated bonds issued by European insurers, especially the ones from France and Italy, have come under pressure,” he said. “It’s absolute cherry-picking time at the moment for investors who understand the bonds’ documentation.”

Even if Solvency II leads to more redemptions, it won’t mean insurers will follow some European banks in buying back bonds before their call date, said Quijano.

“I wouldn’t expect lots of extraordinary buyback offers by insurers at current prices in a way we’ve seen them with banks as there is no comparable pressure on insurers to improve their core capital figures,” he said.

In case of bankruptcy, subordinated bonds are only repaid after policyholders and senior debt holders. Some notes also allow the issuer to stop paying interest or reduce the principal if the company’s solvency is threatened or if it’s unprofitable.

‘Complex Asset’

“Subordinated bonds are a rather complex asset and investors need to closely examine their prospectus,” said Moritz Rehmann, who helps manage about $14 billion at DJE Kapital AG in Munich. “Axa may be seen as more risky than other European insurers due to its exposure to French banks.”

Axa, Europe’s second-biggest insurer after Allianz, held

10.4 billion euros of government bonds from Italy, Spain, Portugal, Ireland and Greece, net of tax and policyholder participation, the company said Aug. 4. About 49 percent of its 142 billion-euro corporate bond portfolio was invested in notes issued by the financial industry, Axa said.

“We currently have no plan to buy back our debt,” a spokesman from Axa said. Allianz declined to comment on future plans regarding their subordinated bonds.

‘Best Value’

“Given that Axa is not affected by the losses under most scenarios, the recent widening seems greatly overdone and provides some of the best value,” BNP’s Villarreal wrote.

European insurers have already started redeeming subordinated bonds.

Aviva Plc, the U.K.’s second-biggest insurer, yesterday announced it will redeem 800 million euros of subordinated notes on their Nov. 14 call date. The bonds were trading at 99.5 cents on the euro the day before the announcement.

Zurich Financial Services AG, Switzerland’s biggest insurer, exercised an option to buy back $1 billion in two subordinated bonds in November at par value. The notes were trading at about 92 cents on the euro before the buyback.

Munich-based Allianz redeemed $500 million of subordinated bonds in May, paying back principal plus any interest accrued until the redemption date. The notes were trading at 101.69 cents on the euro before the announcement.

More insurers may follow with redemptions of subordinated debt as low interest rates mean that strategy can offer attractive returns, said DJE Kapital’s Rehmann.

“As soon as there is more clarity on the final calibration of Solvency II, redeeming subordinated bonds that don’t qualify as core capital could be the next big thing for insurers in Europe,” he said.

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