When it comes to hybrid capital, the name of the game has changed completely during the financial markets' volatility of recent months.
"If we had been having this conversation a couple of months ago, it would have been all about which of the various opportunities and various markets issuers should take advantage of, and which structure would be best," says one FIG syndicate banker. "Now that has completely changed.
"What needs to be asked now is: where is the demand? It is no longer a question of which market offers the best level; rather you simply need to try to find investors that, firstly, have money to invest, and, secondly, like the levels of the market."
Jon Roase, head of financial institutions syndicate at RBS in London, warns insurance companies not to expect a sudden recovery. "Unfortunately these higher levels are not a short-term blip," he says. "We will not return to the levels seen in the first half of 2007 any time soon.
"Insurers might not have to fund themselves right now, but they will be looking at significantly higher levels when they do."
In the short term, Roase says, the structures that have appeal beyond bank related and perhaps leveraged investors should be more feasible. "We see strong demand in five to 10 year fixed rate product from asset managers and insurance companies," he says. "Bank investors and hedge funds have been quieter, although some of the larger hedge funds have been active."
And, until mid-September, at least, the US markets appeared a lot more receptive to new issues than Europes. "It is a combination of two things," says one syndicate manager in London. "Firstly, US issuers are more willing to issue at the new levels they have got the joke that levels arent getting better anytime soon.
"And, secondly, this is in conjunction with US investors being more willing to pick up bonds at cheap levels."
No insurance liquidity crunch
One reason that has often been cited as a factor in the tightening of insurance hybrids and hybrids in general has been that if investors have been willing to take exposure to a name, they have been increasingly happy to take exposure to that name further down the capital structure. Investors also preferred to invest in a hybrid with the same rating as senior corporate paper since the likelihood of the actual issuer going bust was lower for the former than for the latter.
This line of argument has broken down in the recent volatility. "You would have thought that investors would be happy to buy the same securities they bought from banks and insurance companies six months ago at a 200bp wider spread today," says one FIG syndicate manager in London. "But of course the reason that they are trading 200bp wider is that investors are not doing that."
Insurance DCM bankers suggest that this may make it more likely that issuers will aim to come to market with bonds higher up the capital structure. Insurance credits such as Legal & General and the Society of Lloyds might have been able to price tier one paper pre-summer at the levels they had sold their previous upper tier two issues at, but that dynamic has gone into reverse.
"Continental insurers that do not get regulatory credit for tier one-like issues might think twice before adding the bells and whistles that rating agencies want and investors will increasingly charge for," says one hybrid structurer in London.
Indeed, investors question just how soon the insurance hybrid pipeline will begin to flow again, especially given that banks, which are more reliant on the capital markets, have yet to venture so far down the capital structure.
"What we have seen in terms of bank issuance is lower tier two at best," says one portfolio manager in London. "There is nothing on the horizon anytime soon more subordinated than that, except for the financings of RBS, Fortis and perhaps Santander, which have to come to market because of the ABN Amro bid.
"In the meantime, banks are scrambling around to issue as much senior and lower tier two as they can."
However, the fact that insurance companies do not have to come to market and, unlike their banking peers, can remain aloof from the market is seen as a credit positive for the sector.
"It seems that what is affecting the banks is the liquidity issue, which was triggered by their exposure to subprime, conduits and all the rest," says one credit analyst in London. "Insurers have very little exposure to these types of assets and have offered something of a shelter from all the liquidity problems the banks are facing.
"They are not free from exposure, but most of their liquidity comes in from premiums, so they should be able to ride out the volatility without too much damage. And what exposure they might have, they can classify as hold-to-maturity and they wont have to mark it down too much."
Other investors agree that insurance companies have come out of the recent turmoil in a positive light. "The insurers seem to be performing better than the banks, which is a big change," says the portfolio manager.
Indeed the volatility is cited by investors as perhaps the only cloud on insurance companies horizon. "Apart from that they seem to be doing fine," says one.
This is partly because in the physical world, conditions have been calm. "Reinsurance has been blessed with a really benign hurricane season, which is for the second year in a row," says one fund manager in Paris.
M&A raises hopes and fears
The only concerns that investors appear to have about the insurance sector are name-specific, although these are also few and far between. One investor, for example, is following the Resolution saga in the UK closely.
Resolutions preferred merger partner is Friends Provident, and the two agreed terms in July, but Pearl has long been interested in getting together with the insurer and in mid-September Standard Life threw its hat into the ring. Although neither Standard Life nor Pearl had put in firm offers by the time of going to press, they were both running their eyes over the insurers books.
Bond investors in Resolution have been following developments keenly. The specialist manager of UK in-force life funds has a £500m perpetual non-call 2016 tier one issue outstanding, launched by JP Morgan, Lehman Brothers and RBS in November 2005.
"There is some movement around Resolution that is something of a black and white situation from a bondholders point of view," says one credit analyst in London. "If they go with Friends Provident then it will be credit neutral to slightly positive, and if they go with Standard Life, then it will be more or less the same outcome.
"But if Pearl buys them then that would be a bad outcome, although just how bad would depend on the financing terms of any transaction."
The only other M&A activity on the horizon appears to be of interest to investors regardless of its effect on credit quality. Scor, the French reinsurer, which is acquiring Converium of Switzerland, already has hybrid capital outstanding, comprising a Eu350m tier one-type instrument launched in July 2006 by BNP Paribas. Norways Storebrand, which is buying Swedens SPP, has been a rare visitor to the debt capital markets, but plans to issue tier one and lower tier two capital to finance the acquisition.
"If Storebrand comes with some sub debt to finance SPP then it will be a welcome opportunity to look at them and diversify into a new name," says one fund manager in London. "However, market conditions are such that it is going to take a little while before they come with their financing."
Covering all bases
One market that can prove temperamental even when conditions are benign is the retail market, which can be just as heavily influenced by a turn in interest rates or equity market expectations as anything with having a direct effect on the credit markets.
The market opened briefly in May, just before the recent turmoil began, when asset managers new-found interest in hybrid capital and attractive conditions prompted Aberdeen Asset Management to launch a $400m perpetual non-call five tier one issue through Merrill Lynch in May. This was rated BBB (low) by Dominion Bond Rating Service (DBRS) and paid a coupon of 7.9%, inside the 8% guidance on the back of a $3bn book.
The deal was the first Asian retail targeted issue from a European issuer since luxury car-maker Porsche had launched an unrated $1bn corporate hybrid in January 2006, but other financial institutions were quick to jump into the sector in Aberdeens wake. BNP Paribas, Lehman Brothers and, most interestingly, International Securities Trading Corporation, which runs itself according to banking standards and principles, but mainly invests in subordinated debt. The $235m issue, led by HSBC and Merrill Lynch, showed just how willing Asian retail was to look at unusual credits when a 9% coupon is on offer.
However sentiment quickly turned. "Before the recent flurry of issuance yields had been grinding higher and sentiment was very positive," said a syndicate manager at Lehman Brothers in London. "The coupons that were achievable looked attractive on an historic basis and there had been a lack of supply, so there had been a build-up of demand for the product.
"However, as yields started to gap higher, the market started to soften with investors backing away from the market," he added. "Investors in this product like to feel they are buying at local highs (yields)." Insurance DCM officials say that the smaller volumes usually available through retail transactions and the unreliability of the market, whether in Europe or Asia, mean that it is, at best, a complementary source of finance alongside the institutional market.
"Issuers can take out maybe Eu200m-Eu300m at a time, which is helpful when you are growing your capital incrementally," says Vinod Vasan, head of capital products at UBS in London. "But when they need to finance an acquisition and therefore need the certainty that they can raise a large volume then the institutional market is very much the one that they will turn to."
Like its institutional market, the US retail market is, however, seen as a more reliable source of financing witness the ability of Barclays Capital to take $2.05bn out of this market in early September.
Insurance companies have also been availing themselves of as many institutional markets as possible. Axa and Swiss Re, for example, have issued high equity content hybrids in four major institutional markets: dollars, euros, sterling and Australian dollars."Both have issued into the four main hybrid markets," says UBSs Vasan. "That is firstly because they are sold on the idea of raising hybrid capital but also because they do not want to over-issue into any one currency or investor base."