Axa: Quality return after volatility

Axa reopened the euro hybrid insurance sector on 23 March to sell its first new subordinated issue since 2014, a Eu1.5bn 31.25NC11.25 Tier 2 deal. Here, Nicolas Benhamou-Rondeau, Axa head of funding and capital markets activities — group treasurer, discusses the trade’s execution and how evolving regulations are affecting the insurance hybrid space.

What was the rationale for this transaction?

The transaction was part of our funding programme for 2016, aiming at refinancing part of our outstanding debt.

The choice of a Tier 2 instrument was in line with the group’s strategy communicated in December during our investor day, which gave some guidance on our capital management framework. With our group benefiting from a strong capital base and significant capital generation, we have the flexibility to rebalance our hybrid debt mix from Tier 1 to Tier 2. This obviously allows a cost optimization whilst taking advantage of our available Tier 2 capacity. The new Tier 2 was therefore a natural and efficient refinancing operation.

From a marketing perspective, we were confident a Tier 2 structure would be well received. The instrument is well understood by the market and is attractive to investors given the absence of loss absorption mechanism, cash cumulative coupons and step up.

Therefore, we considered the instrument would offer a good mix between risk and return in the current market environment. Additionally, we believed negative swap rates up to five years (or close) would clearly invite investors to move further on the maturity curve and in the subordination spectrum, which is very positive for the insurance hybrid market.

Market conditions were challenging in the first few months of the year, with subordinated products feeling the full force of the volatility. How did you navigate this difficult environment to execute a successful transaction?

Indeed, markets were extremely volatile early in the year and remain volatile so far this year, and we knew that a timely execution would be decisive. We had to be patient while keeping abreast of potential market turnarounds. We had the structuring phase finalised by January and we wanted to be in a position to hit the right market window.

Market conditions did not allow any execution in February given the strong risk-off sentiment mostly driven by concerns on oil prices and global growth, which pushed hybrid secondaries materially wider. The negative backdrop on AT1 amplified that sell-off.

By early March, the tone in the credit market became stronger, finally catching up with the rally we had been seeing over the previous few weeks in the equity markets, and the primary markets showed signs of life. However, our key concern was the potential for a very elevated new issue premium being required by investors given such volatile markets.

Two key triggers validated our execution window. First, the BNP Paribas 10 year Tier 2 deal — which, if I remember correctly, was the first subordinated euro deal since the market dislocation in January — was positively received with a limited new issue concession. Axa, like BNPP, benefits from strong name recognition and it was very encouraging to see that investors were now fully engaged in the hybrid space, at least for strong names.

The second driver was obviously the latest round of ECB stimulus announced at its March meeting.

Post-ECB announcement, the primary markets were extremely supportive, being the only place where investors can add risk in size. In secondary, even if activity was fairly limited, our Tier 2 levels had retraced most of the early 2016 widening move, most likely also supported by the recently published strong set of results.

Yet, we had not seen any subordinated insurance deals in the euro market in 2016. So we felt that the first mover would have the greatest advantage.

We therefore decided to target the week of 21 March to take advantage of the constructive tone and to avoid the growing pipeline in the FIG primary markets post-Easter break.

The tragic events in Brussels on 22 March led us to wait further and we finally decided to announce the deal the day after, with a constructive market backdrop and investors still very much engaged despite Easter approaching.

At the end of the day, we achieved the lowest coupon ever (3.375%) for an Axa subordinated transaction.

With more than 300 investors involved in the transaction, is that an encouraging sign of investors’ confidence in Axa’s credit and also insurance hybrid markets more generally?

The extremely granular order book, with around 300 investors participating, clearly demonstrated Axa’s very strong access to capital markets and the very good understanding of investors of its credit.

We were confident that the transaction would garner a lot of interest. First as I previously mentioned, fixed income investors are currently searching for yieldier products but would also tend to favour strong investment grade credit.

Secondly, Axa remains a relatively rare issuer in the hybrid capital space. The last time we came to the markets was in November 2014 and still it was only available to investors participating in our exchange offer. So basically our last public deal was actually in May 2014.

Finally, the euro market is our natural and core market and has proven depth.

We were extremely happy with the quality of the book. The final order book of more than Eu4.3bn was very granular, dominated by UK and French real money investors.

This overwhelming interest from investors allowed the order book to build very quickly, reaching the Eu2bn mark after only 90 minutes. The momentum in the transaction continued, with books growing steadily despite a 15bp tighter move from initial price thoughts.

With secondary levels having moved marginally since then, we believe we achieved the right level.

More generally — to fully answer the question — insurance hybrid paper is probably a rare asset class in the FIG space and investors are often keen on diversifying their investments. With Solvency II disclosure starting to be very well understood by the investor community, receptiveness to insurance hybrid paper is building up consistently.

What were the determining factors for the longer 31.25NC11.25 rather than the standard 30NC10 structure?

First and foremost, having a first call in 2027 helps smooth our debt maturity profile. Given the grandfathering period, the 2025/2026 bucket is relatively full with several Tier 1s having their first call dates around this period.

Furthermore, a long 31NC11 instrument allowed us to have our six month look-back pusher fully operational as Axa’s dividend is usually around May.

Finally, given the flattening of the rate curve, investors’ appetite remains strong for longer maturities.

With a size of Eu1.5bn, this was the largest subordinated Axa trade ever. What was the rationale for printing such a size?

The group targeted a benchmark size with the idea of printing at least Eu1bn. A Eu1.5bn deal was at the high end of our target. But given the very few available windows so far and the potential headwinds to come this year from macro news, namely the Brexit referendum, the Greece/Spanish uncertainties, or central banks’ sometimes hard to decode messages, we chose to maximize the size.

The choice was even made easier given the granularity and the size of the order book, which allowed the large size not to be detrimental to the pricing.

How did you take into account the ACPR’s position on tax-related features in subordinated instruments?

We incorporated the recent recommendation of the ACPR on Tier 2 to extend from five to 10 years the early redemption right for tax reasons on withholding tax.

We understood from our regulator that they consider the gross-up clause combined with a call option as an incentive to redeem. As a result, the possibility to redeem the bond in such an event is now optional and cannot be done before 10 years, unless replaced by instruments of at least the same quality.

Preserving the gross-up concept was, however, key, in our view, in order for French insurance paper to stay on that aspect in line with industry practice, investors’ expectations, but also banks’ and corporates’ standards.

Finally, it should be noted that we included a “redemption alignment clause” allowing us to come back to the initial minimum five year maturity should the regulation change.

An “insolvent insurance affiliate winding-up” event has been inserted in the conditions to redemption and purchase. What is the purpose of this new provision?

After the PRA and the DNB positions on Recital 127 of the Delegated Act, we understood a specific contractual provision would be desirable to our regulator. The intention of Recital 127 is notably to prevent the repayment of any hybrid debt at the holding level should an insolvency event occur within any affiliate of the group.

Given the scale of our group, with many affiliates (sometimes with a relatively limited size) and several joint-ventures outside the EU, we were concerned that the automatic and systematic nature of such mechanism could have unexpected adverse consequences without necessarily solving the issue.

To mitigate this systematic effect, we have added a clause that allows the bond to be redeemed even if an “insurance affiliate winding-up” event has occurred should prior approval by the ACPR be exceptionally given. This allows for some form of materiality test on the event prior to blocking the bond repayment.

What are your plans for issuing other capital instruments such as Solvency II Tier 1?

As mentioned previously, the group has flexibility in terms of hybrid instruments and Tier 1 is not a priority for the moment.

This does not, however, preclude future use of Solvency II Tier 1, but not immediately.

Do you expect issuers to view Solvency II Tier 1 instruments as a viable way to raise capital?

Most of the recent SII publications showed strong Solvency II ratios, and that despite the market volatility. Moreover, as currently designed, the instrument would probably in most cases not cure any breach of the Solvency Capital Requirement (SCR), but would only strengthen the capital structure.

In addition, the structuring uncertainties that remain — for instance on the write-down/write-up mechanism — make it complicated to fully structure it for the time being.

Finally, pricing-wise, we can expect a significant premium versus old-style Tier 1.

In short, there is in theory no hurry to issue under such a format and most likely some fine-tuning to be performed. This being said, ongoing discussions of certain issuers with their local regulator and specific needs in some cases might result in Tier 1 issuances coming to the market in some jurisdictions sooner rather than later.

From an investor’s perspective, the demand should be strong. Most investors likely to participate in new SII T1 transactions are already active in the bank Additional Tier 1 space. They are familiar with the concept of coupon and principal at risk.

I expect the key focus to be around the distance to trigger and the availability of distributable items to serve RT1 coupons. The recent disclosure on Solvency II provided more comfort to investors on European insurers’ solvency positions, notably in terms of granularity of the capital structures, the capital targets, the sensitivities of the ratio.

I am also convinced that the structure could be seen as more friendly than AT1 given, for instance, the wider distance to trigger, investment grade rating for prime issuers, and no Maximum Distributable Amount concept for the time being.

What do you think of contingent capital instruments designed to mitigate the volatility of the solvency ratio margin?

Mitigating the volatility of the Solvency II ratio is a key objective in the insurance sector. This can actually be achieved with various capital management strategies targeting either the SCR itself or the available solvency capital.

When considering available solvency capital, there are a variety of contingent capital instruments currently being marketed. Some structures aim, for example, at building on the concept of ancillary own funds introduced by Solvency II.

Different triggers, host securities and conversion instruments can be envisaged, some being more efficient than others to mitigate the ratio’s volatility.

However, for those that have been publicly issued, I personally still view them as expensive tools, in particular when the instruments do not provide any capital recognition on day one.