RT1 passes major insurance test in ASR EUR300m hit – plus RT1 FAQ

ASR Nederland sold the first Restricted Tier 1 (RT1) instrument in a major currency on 12 October, a EUR300m perpetual non-call 10 transaction that attracted over EUR2.6bn of orders and achieved pricing that market participants said positioned the insurance instrument favourably versus bank AT1.


The first ever RT1 was a NOK1bn deal for Gjensidige Forsikring in August 2016 and the only other supply has been in Danish kroner and Swedish kronor from RSA Insurance Group, in March. Being in euros, ASR’s landmark was therefore seen as an important test for the new Solvency II instrument.

The perpetual non-call 10 deal — rated BB by S&P — attracted over EUR2.6bn of orders from 110 investors, allowing for pricing with a 4.625% coupon, following initial price thoughts (IPTs) of the 5% area and revised guidance of 4.625%-4.75%.

Chris Figee, ASR CFO (pictured below), deemed the deal a great success and said the 4.625% coupon reflected investors’ strong confidence in the company.

“ASR has demonstrated today its commitment and proactive approach to responsible long term oriented financial management through an innovative and market leading transaction,” he said. “We are proud to have issued the first euro-denominated insurance RT1, which further underpins ASR’s strength and position in the capital markets.”

Chris Figee CFO ASR

A key pricing reference was bank AT1, in particular a 4.75% perpetual non-call 2027 instrument of ABN Amro, rated Ba1/BB+ (Moody’s/Fitch), issued on 27 September. Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB, said ASR’s IPTs had been aggressive – given the one notch lower rating and sub-benchmark size — but that the pricing flat to inside ABN Amro and nine-times oversubscription made for an “exceptional result”.

Michael Benyaya, capital solutions, DCM at Crédit Agricole CIB, said investors viewed ASR as an ideal name to open the RT1 sector in euros, given its positive credit story, and that the deal’s success had been reinforced by a thorough roadshow explaining the merits of the instrument.

“One of the key focus points was the comparison with bank AT1, because the instrument looks very similar to bank AT1 in its overall structure,” he said. “But the result shows that investors took comfort from the specificities of the insurance Solvency II framework which make the instrument slightly more investor-friendly in two main ways.”

The first is in respect of coupon cancellation, according to Benyaya, there being a regulatory waiver whereby the coupon can still be paid even if a solvency trigger has been breached if the regulator agrees.

“The second one, which is equally important, is in terms of loss absorption mechanism,” he added. “There is a grace period of three months, so if the SCR ratio is between 75% and 100% the insurance company has three months to cure the breach, and during that time there is no loss absorption while the insurance company has the capacity to implement various measures to restore the capital position. ASR’s investor presentation was well drafted on that point because they had a specific slide on the various measures — around 15 — that they could take to very quickly improve the capital position.

“This sort of communication was well received and also well understood by investors.”

Among the reasons for launching the RT1, ASR cited the financing of its acquisition of Generali’s Dutch operations.

“With this transaction we have successfully added a new instrument to our capital management toolbox,” said ASR’s Figee. “We maintain ample headroom in all capital tiers and our financial flexibility remains very strong.”

While market participants are not getting carried away with the opening of the RT1 sector in a major currency, ASR’s issue is seen as improving supply prospects.

“We will see more RT1 going forward as issuers will of course look at refinancing existing debt and also potentially taking advantage of the good market conditions for these kinds of instruments,” said Benyaya. “And the success of ASR will probably unlock such supply given that investors are apparently very keen in investing in the new product.”


What is the rationale for issuing RT1?

Michael Benyaya, CACIB: In the banking space, the rationale for issuing AT1 is pretty obvious given the role and position of the combined buffers requirements in the regulatory capital structure as well as potential ratings benefits, e.g. S&P RAC.

In the insurance regulation, there is no such strong incentive to issue an RT1 and we need to consider the financial flexibility of the issuer to find a rationale for RT1 issuance. Optically, Tier 2 capacity looks large based on the 50% SCR limit. I believe issuers will probably rather manage the Tier 2 bucket on the 35% limit to retain room for DTAs or potentially ancillary own funds. On that basis, at some point the Tier 2 capacity will simply not be large enough to host the refinancing of grandfathered Tier 1 and issuers will need to turn to RT1. Issuers will aim to retain a certain balance between RT1 and Tier 2 and will carefully manage the Tier 2 capacity to be able to issue Tier 2 in case of need.

Finally, the rating driver is pretty weak for now because an RT1 does not bring any additional equity credit compared to a Tier 2 in the S&P insurance capital model.

Michael Benyaya image

So far national champions have been absent from the RT1 market — why is that?

Benyaya: The RT1 market has indeed opened with smaller insurance companies. It contrasts with what we saw in 2013 and thereafter in the bank AT1 market, where large banks were present from the outset. In the insurance sector, there is no urgent need to issue this instrument. Insurers are overall well capitalized and they have been able to refinance debt maturities with Tier 2 until now. Longer term, as I said previously, the tiering limits will start to bite and national champions will certainly be active in the RT1 market at some point.

What is the current status of discussions in terms of structuring features?

Benyaya: The discussion is still live and there are a few questions outstanding. EIOPA has recently launched a consultation on Solvency II own funds, including RT1. The consultation discusses various structuring items, but I would like to focus here on the principal loss absorption mechanism (PLAM).

It is well known that the Solvency II PLAM does not cure the trigger breach in the vast majority of cases because it is set by reference to total capital. This will not change, and we need now to focus on the structuring of the PLAM, the partial write-down in particular, to make it comprehensible to investors.

So far we have only seen the equity conversion format in the RT1s issued by the UK and Dutch issuers. This format is certainly very robust from a regulatory standpoint, but some listed companies are not ready to issue this format as there may be a need for specific authorizations to be passed at the shareholders’ assembly. For the unlisted and mutual insurers, the full and permanent PLAM is also a credible alternative and seems regulatory-proof.

The partial principal write-down is still in development. EIOPA has proposed a linear write-down mechanism whereby the instrument should be written down fully at least at the point at which SCR coverage falls to 75% or the MCR is breached. In practice, and If implemented, this mechanism probably means that investors will face high losses even before the 75% threshold is reached if we assume that the write-down percentage increases linearly between 100% and 75% SCR coverage.

The write-up mechanism is not addressed in the EIOPA consultation. The UK PRA does not allow the write-up and some other regulators seems to share this view. But nothing is really set in stone as I have not seen public statements from continental European regulators on the write-up.

What are the key points for investors?

Benyaya: Beyond the profitability and the credit fundamentals of the issuer, the solvency position will be a key focal point. The resilience of the solvency margin will be important and this could be partly assessed with the sensitivities. In addition, investors will contemplate the management actions that could be implemented when the margin gets closer to the trigger or during the three month period when the SCR is below 100% but above 75%.

The concept of resolution in the insurance space should not be ignored and investors could question its meaning and potential consequences for debtholders. EIOPA has only called for a minimum harmonization of European resolution schemes and I believe that bail-in will remain largely absent from resolution frameworks. It’s true that the insurance resolution framework in the Netherlands will include bail-in, but in France it is not part of the framework that should be finalized soon.

What is the outlook for the insurance DCM primary market in 2018, and particularly RT1?

Benyaya: In 2017 volumes have been fairly low for European issuers and this was largely expected by market participants, including us, I believe. As we speak, we have not identified a strong factor that could result in a surge in volumes next year. Buoyant M&A activity could trigger some additional needs, but large cross-border deals are off the table when we listen to the top management of national champions. They seem to be focusing on bolt-on acquisitions that could be largely financed with internal resources and excess capital.

2018 volumes could still be higher than 2017 because a number of large issuers have been absent from the market this year and will certainly be active next year. In terms of currencies, issuers’ appetite for US dollars will continue to be driven by the arbitrage (or lack thereof) afforded by this currency. In terms of RT1, issuers will not necessarily wait for the full clarity on EIOPA final standards and 2018 could definitely see some large insurers taking the RT1 plunge.