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Interesting New Issuance

13 October 2016 by Mark Holman

Yesterday fixed income markets in Europe saw a new type of issuance from the insurance sector. Labelled “tier 3 capital”, it is loss absorbing but senior to all tier 1 and tier 2 capital of the issuing insurance company. Coupons can be waived when capital falls below regulatory thresholds but they are cumulative and must be repaid again later.

The interesting feature of tier 3 capital is that it can be much shorter, not just to call date, but to maturity, as this debt does not need to be perpetual. In fact the regulations state that it only needs to be a minimum of 5 years. With so much capital sitting beneath this tier 3 capital and the bullet nature, as well as much stronger ratings, it was bound to provoke interest.

Yesterday’s inaugural issuer was CNP, the French insurer, who issued €1billion of 6 year notes at a spread of 233bp over the equivalent German Bund. Rated BBB+ it would be in all the investment grade indices and be high yielding at that, given that the average yield on the € IG index is just 0.73%. Consequently the lead managers amassed books in excess on €7bn for this new structure, and naturally the deal has performed well on the break.

We would expect other insurers to follow suit, as this is a cheaper form of capital for them, so more supply is to be expected. Having said that, the supply won’t be overwhelming as insurers are not as capital intensive as banks due to much lower leverage, and an additional rule that only allows 15% of their capital to be made up of this tier 3. We do note however that tier 3 capital will not receive any credit under the S&P model, hence it may prove to be popular for those issuers who are less sensitive about their rating; obviously not an issue for a strong credit like CNP.

To date all major European insurers have continued to call their longer dated tier 1 and tier 2 capital at the first call date, regardless of the economics of the call. Now with cheaper tier 3 issuance available there is an additional fillip for callable insurance paper as the economics for calling less efficient tier 2 and replacing with tier 3 are compelling.

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