ASR RT1 will be market-defining if not market-generating
Restricted tier one (RT1) bonds still do not make sense for Europe’s insurance industry and the asset class needs benchmark issuance before it can become a significant market in its own right. But the first deal in a major currency from ASR Nederland will be a very important line in the sand.
A couple of years ago you would have found plenty of financial bond market participants heralding the emergence of an RT1 market in Europe.
But for all the talk about the insurance sector laying claim to their own version of the additional tier one (AT1) paper sold by banks, there has been nothing but a couple of small, niche currency trades in the intervening period.
One of the big problems deterring issuance was that insurance companies were unsure whether or not tax authorities would treat RT1 securities like bonds or shares, as — similar to AT1 — the instruments have bond-like payment structures, but equity-like downside risk. If treated like shares, tax officials would likely tell issuers to deduct their interest payments from post-tax rather than pre-tax profits.
That cloud seems to be lifting with ASR Nederland printing its first RT1 in a major currency on Thursday. The Dutch firm was able to confirm with GlobalCapital that it would be paying its RT1 coupons out of pre-tax profits, effectively lowering the cost of payments by about 25%.
Other insurance firms considering issuing RT1 are likely to take courage from these developments. And there are plenty of reasons to think that it could be an ideal time for the new market to start putting down roots.
Interest rates are only likely to rise in the coming years, market conditions have been incredibly benign in 2017, and insurance debt has been exceptionally sought after by investors in recent weeks. ASR Nederland said it was looking to take advantage of these conditions to refinance old tier one bonds up to two years in advance.
“The timing of this new transaction is spot-on,” noted Gary Kirk, a partner and portfolio manager at TwentyFour Asset Management.
Keeping a lid on it
But market participants should beware sounding another starting gun for the RT1 asset class — as the development of the market is likely to be far slower than the roll-out of new bank products in recent years.
Unlike European banks when AT1 structures started to emerge in 2013, insurance firms are stuffed with capital from other sources, including tier one capital through value in force, shareholder’s equity and other items. Any subordinated bonds that companies add into the equation must be worth the cost.
Solvency II rules require insurers to meet a minimum of 50% of their solvency capital requirements (SCR) with tier one capital — of which tier one subordinated bonds are restricted to 20% — while tier two and tier three capital is capped at 50% of the SCR. But it all effectively goes into the same bucket.
“RT1 doesn’t do much more for them than what dated capital does,” said a head of bond syndicate this week. “It’s not the same impact as the difference between AT1 and tier two for a bank.”
And ASR Nederland itself has only found room for a €300m perpetual non-call 10 year trade.
So even though the Dutch firm has landed the first RT1 in a core currency this week, the market is still without a benchmark trade — essential for the market to develop and welcome a broader and deeper pool of investment, and for establishing a proper price point with acceptable liquidity.
Dude, where’s my coupon?
But that is not to say that ASR Nederland’s pioneering trade is not an important milestone. In fact, it could be crucial in dictating the pace and size of the RT1 market’s growth.
RT1 structures are unlike any other subordinated bonds issued by insurance companies — the issuer has the discretion to cancel interest payments at any time and must cancel payments if does not have enough distributable items or lacks the funds to meet its SCR or minimum capital requirement.
Despite a few wobbles in the past, this concept is understood by the bank capital market — where banks have to stop paying AT1 coupons if they erode the capital buffers beyond their maximum distributable amount (MDA) trigger points. But this is very unfamiliar ground in the insurance market, as investors have been asked for the first time to assess a premium for the risk of coupon deferral.
ASR Nederland’s 4.625% coupon marks a line in the sand in this respect, helping to determine whether the market values SCR triggers in a similar way how its values MDA triggers.
While this offer has not launched the European RT1 market, it is a big towards one forming. Other insurance firms will be watching developments with acute interest.