* Long wait ahead for first insurance Tier 1 bond
* UK insurers could lead the way
By Alice Gledhill
LONDON, May 15 (IFR) - UK insurers could be among the first to go ahead with raising new-style Tier 1 debt, though any issuance is unlikely to open the floodgates as well-capitalised borrowers shy away from what will be an expensive part of their capital stack.
In a supervisory statement published at the end of April, the UK Prudential Regulation Authority laid out the characteristics capital instruments need to have in order to be classified as capital, laying the ground for potential issuance.
"Since the PRA detailed its requirements, a UK insurer could be among the first to issue Tier 1 capital under the new guidelines," said Filippo Alloatti, senior analyst at Hermes Investment Management.
Banks have monopolised the market so far, bolstering their balance sheets with EUR76bn-equivalent of Additional Tier 1 capital since it opened in 2013, while insurance companies have been notable in their absence.
"We'd expect the UK to come first because it didn't allow the work-around that continental regulators allowed," added Neil Williamson, head of EMEA credit research at Aberdeen Asset Management. "So if there is a 'pressure point' to replace Tier 1 capital that is rolling off, it could be the UK."
Numerous continental insurers such as Credit Agricole Assurances, Intesa Sanpaolo Vita and Sogecap took advantage of provisions that allowed them to issue cheaper Tier 2 paper that could be grandfathered as Tier 1 under Solvency II. But the UK regulator did not permit UK insurers to do the same.
Pru has been flagged as a prime candidate thanks to its comparatively weak capital structure.
Appetite on the buy-side could offer some incentive to issue, particularly because these notes will have to pay hefty coupons to compensate investors for loss absorption features - now familiar from AT1s - such as write-downs or equity conversion. Rabobank's EUR1.5bn AT1 bond in January, for example, offered an additional 4.125% over a EUR1.5bn 12-year senior bond issued the same month.
However, while Tier 1 issuance from insurance companies could provide some welcome diversification for investors, many argue that the market could be slow to take off.
Generous grandfathering provisions are one obstacle while current strong capitalisation levels another.
" can be opportunistic but most issuers follow a pattern of refinancing prior to or at the time of maturity or the first call date," Rafael Villarreal, a credit analyst at BNP Paribas wrote in a note this week.
"Supply should remain linked to refinancing and some capital structure optimisation after the introduction of Solvency II."
Most existing bonds present a first call date between 2015 and 2018, according to CreditSights analysts.
Meanwhile, BNP Paribas's Villarreal added that new Tier 1 instruments being too equity-like could potentially preclude some investors from buying them.
"If rated, most likely the rating companies would rate them as borderline speculative grade for the strongest groups and speculative grade for medium to weaker companies. Again, this rules out other investors," he wrote.
How to price Tier 1 will be another knot for investors to unravel. The loss absorbency of Tier 1 bonds will rest on the sensitivity of the company's Solvency Capital Requirement (SCR) but investors will have limited insight into this, with most insurers assessing their SCR through internal models.
There are also concerns that a more relaxed attitude towards capital rules, at least in contrast to banking regulators, could weigh on the risk profile of European insurers.
CreditSights analysts have highlighted the relatively weak definition of capital under the new regulatory regime; for example, European insurers will be able to count Value in Force (Tier 1), letters of credit (Tier 2) and net deferred tax assets as capital (Tier 3). (Reporting by Alice Gledhill, editing by Helene Durand, Julian Baker)