Swiss Re completes dual solvency/catastrophe trigger contingent deal

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by ARTEMIS on OCTOBER 4, 2013

Reinsurance firm Swiss Re has successfully completed its novel dual-trigger contingent capital security transaction, having sold CHF175m Swiss francs of notes linked to either the occurrence of a major decline in its solvency level or a major natural catastrophe loss.

We wrote about this interesting transaction at the start of last week when the offering launched to a broad community of investors. The unique deal is the first we’ve seen to include two trigger conditions which if either occur could cause the full principal of the notes to be written off.

As such this is better thought of as a contingent write-off deal, rather than contingent convertible (CoCo). Although it is being called a catastrophe contingent convertible by some.

The two triggers in the transaction provide Swiss Re with protection through a source of capital secured by the sale of securities notes to investors against either of a decline in the reinsurers solvency ratio or the occurrence of a major catastrophe loss event.

The first trigger is based on Swiss Re’s solvency as measured under the Swiss Solvency Test (SST). If Swiss Re’s solvency test measurement falls below 135% at any time during the term of the notes, the contingent write-off notes would be deemed triggered and investors would lose their principal. The second trigger is linked to the catastrophe event. It is designed to provide Swiss Re with contingent capital in the event of a 1 in 200 year Atlantic hurricane using an industry loss trigger. We’re told that the trigger for this may move based on an annual reset but for launch the 1 in 200 year hurricane event industry loss has been set at $134.3 billion of insured losses.

The deal was marketed very widely, contingent transactions tend to have broader appeal than pure catastrophe bonds meaning that Swiss Re could tap into a much broader investor market and further diversify its sources of risk capital with this deal.

A bond market analyst source told us that the transaction priced on Monday at 7.5%, for a 32 year maturity note with the option for the issuer to call the notes at par in year seven of the deal and thereafter. CHF175m (Swiss francs) of notes were sold to investors.

The pricing on the transaction settled around the middle of the launch range, we’re told. It began marketing with a range of 7.25-7.75%, which was refined to a CHF100m offering at 7.325-7.625%, finally settling at CHF175m at 7.5%.

The range of investors who participated in this transaction is particularly interesting. We understand that insurance-linked securities investors took just 2% of the deal, private banks and high-net worth investors took 48%, hedge funds 23%, family offices 15% and other institutional investors and pension funds took 12%. In terms of geography, Swiss based accounts took 96% of the notes while non-Swiss only accounted for 4%.

We understand the reason for the high Swiss investor base in this contingent deal was that it was offered domestically in Switzerland with Swiss withholding tax. It has been reported elsewhere that Swiss Re has seen the appetite of investors for the transaction and may seek to replicate it elsewhere around the world in other markets where it can tap into more sources of capital.

So with this contingent note offering Swiss Re has secured itself a healthy CHF175m (around $193m) source of risk capital which it will receive in full should either of the trigger events, solvency ratio decline or the 1-in-200 year hurricane, occur. With investors receiving 7.5% interest for the term of the notes they make a very decent investment return over the duration and it’s easy to see why these have been well received.

Contingent capital transactions have long been used to protect firms against financial or economic catastrophe. Now they are beginning to be used to protect against solvency shocks caused by natural catastrophes and so the worlds of catastrophe bonds or ILS and contingent capital collide.

We do expect to see more of these types of transactions, especially as insurers and reinsurers realise the much larger investor audience they can access through them. It will be interesting to see whether Swiss Re do look to repeat this deal in other locations.

Recommended Article on the structuring of Contingent Capital Solutions

By Kailan Shang FSA, CFA, PRM, SCJP, Casualty Actuarial Society (2013)
http://www.casact.org/research/Understanding_Contingent_Capital_Complete.pdf

LIKELY REQUIREMENTS FOR MORE CONTINGENT CAPITAL: Deutsche Bank

LIKELY REQUIREMENTS FOR MORE CONTINGENT CAPITAL:

EXCLUSIVE - Deutsche Bank "horribly undercapitalized" - US regulator

 17 June 2013

By Emily Stephenson and Douwe Miedema
WASHINGTON, June 14 (Reuters) - A top U.S. banking regulator called Deutsche Bank's capital levels "horrible" and said it is the worst on a list of global banks based on one measurement of leverage ratios. 

"It's horrible, I mean they're horribly undercapitalized," said Federal Deposit Insurance Corp Vice Chairman Thomas Hoenig in an interview. "They have no margin of error." 

Hoenig, who is second-in-command at the regulator, said global capital rules, known as the Basel III accord, allow lenders to appear well-capitalized when they are not. That is because the rules allow the banks to use complicated measurements of how risky their loans are to determine the capital they must hold, he said. 

But using a tougher leverage ratio measurement - which compares a bank's shareholder equity to its total assets without using risk-weightings - the picture for banks such as Deutsche Bank is very different, he said. 

Deutsche Bank this year is almost done raising 5 billion euros ($6.67 billion) in new debt and equity, boosting its core capital ratio to around 9.5 percent, which it says has made it one of the best-capitalized banks among its peers. 

"To say that we are undercapitalized is inaccurate because if you look at the Basel framework, we're now one of the best capitalized banks in the world after our capital raise," Deutsche Bank's Chief Financial Officer Stefan Krause told Reuters in an interview, when asked about Hoenig's comments. 

"To suggest that leverage puts us in a position to be a risk to the system is incorrect," Krause said, calling the gauge a "misleading measure" when used on its own. 

Deutsche's leverage ratio stood at 1.63 percent, according to Hoenig's numbers, which are based on European IFRS accounting rules as of the end of 2012. 

Deutsche said the number now stands at 2.1 percent but that it does not look at the gauge. Using U.S. generally accepted accounting principles, the ratio stood at a much more comfortable 4.5 percent, Krause said.
  
OUTSPOKEN CRITIC
The difference is due to the way derivatives on a bank's books are measured. Neither number directly corresponds to the Basel leverage ratio, which calculates capital in another way and sets a 3 percent minimum. 

The FDIC - which guarantees deposits at U.S. banks - stressed that Hoenig was speaking in a personal capacity and that the agency did not comment on individual banks. 

Hoenig staked out a reputation as a dissenting voice against the Federal Reserve's loose monetary policy in the immediate aftermath of the financial crisis when he was president of the Federal Reserve Bank of Kansas City. 

He's also an outspoken critic of the Basel III rules - introduced globally after the crisis - which he says do not do enough to reduce the size of the riskiest banks and are easy for them to game. 

Other banks with a low ratio, according to Hoenig, are UBS at 2.52 percent, Morgan Stanley at 2.55 percent, Credit Agricole at 2.72 percent and Societe Generale at 2.84 percent.     

Detailed rules for Basel III, which other U.S. politicians and regulators have questioned, are expected to come out in the United States in the next few months, well past the January deadline agreed upon internationally. 

DESCRIBES "RIDICULOUS" CHANGE
Hoenig pointed to the gain in Deutsche Bank shares in January on the same day it posted a big quarterly loss, because it had improved its Basel III capital ratios by cutting risk-weighted assets.

"My other example with poor Deutsche Bank is that they lose $2 billion and raise their capital ratio. It's - I don't want to say insane, but it's ridiculous," Hoenig said. 

A leverage ratio is a better method to show a firm's ability to absorb sudden losses, Hoenig says, and he has floated a plan to raise the ratio to 10 percent. He said the 3 percent    leverage hurdle under Basel was a "pretend number." 

Opponents of using such a ratio say that it ignores the risk in a bank's loan books, and can make a bank with only healthy borrowers look equally risky as a bank whose clients are less likely to pay back their loans. 

It also fails to take into account how easily a bank can sell its assets - so-called liquidity - or whether it is hedged against risk. 

Still, equity analysts said that while Deutsche Bank likely will meet regulatory capital requirements, its ratios look weak. 

"(The) capital raise was warmly received by the market," Berenberg Bank said in a note this week. "However, we still remain concerned about the leverage in the business." 

"To get above the 3 percent level (mandated by Basel), required by 2019, requires four years' worth of profits and, in our view, delays dividends." 

New regulations on Contingent Capital for banks in Canada

Fitch: Canada Moving Ahead on Bank Contingent Capital Plan

Fri May 17, 2013 11:44am EDT

(The following statement was released by the rating agency) CHICAGO, May 17 (Fitch) Canadian bank regulators have moved ahead of their global counterparts in specifying the terms under which certain types of contingent capital could be converted to common equity in a bank stress scenario. New forms of nonviable contingent capital (NVCC) instruments will be issued by Canadian banks, but Fitch Ratings will continue to look to core equity capital as the primary source of loss-absorbing protection for creditors in a bank stress scenario. Canada's Office of the Supervisor of Financial Institutions (OSFI) has taken the position that explicit triggers for the conversion of subordinated debt and preferred stock to common equity should be incorporated into documents in order to be included in Tier 1 and total capital ratios. These new instruments will include NVCC triggers that make clear the conditions under which "bail-in" debt and preferred stock will be converted when Canadian banks require more capital and regulators deem them "nonviable." Our approach to notching ratings for banks' subordinated bond and preferred stock issues has not been changed as a result of the introduction of these standards. Fitch revised its global criteria on regulatory capital securities in December 2011 in anticipation of banks issuing Basel III compliant capital instruments. Accordingly, we will continue to notch subordinated debt issue ratings, generally by one notch, relative to the bank's stand-alone assessment, which is encompassed in the viability rating (VR), while preferred stock will be rated five notches below the VR. OSFI officials noted again this week at investor conferences that the NVCC regulatory framework offers a clear and unambiguous view of how recapitalization of banks can take place in a distress scenario. By requiring explicit contractual terms detailing triggering events for conversion of "bail-inable" securities, OSFI believes that the need for weakly capitalized banks to receive taxpayer support in such a scenario will be reduced. The Canadian regulator expects to provide final guidance on the size of the resolution buffer to be maintained by banks in the next few months. The amount of outstanding capital that is not NVCC-compliant will be reduced over the next few years as Canada moves toward full implementation of Basel III capital standards. As NVCC-compliant security structures are finalized, Fitch will focus on the potential for unintended consequences resulting from the addition of new types of NVCC-compliant securities in bank capital structures. Contact: Justin Fuller, CFA Director Financial Institutions +1-312-368-0257 Bill Warlick Senior Director Fitch Wire +1-312-368-3141 Fitch, Inc. 70 W. Madison Chicago, IL 60602 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Fitch rates Swiss Re’s $750m contingent capital note

Reinsurer Swiss Re’s contingent capital bond issuance came to market last month and succeeded in securing the Swiss based reinsurer a $750m source of capital protection linked to its solvency from investors. The transaction received a lot of attention in the press as it came to market and was reported to have been oversubscribed as investors sought another way to acquire yield in these difficult financial markets.

A contingent capital bond allows the issuer to attract investors to provide it with a source of capital which is ‘contingent’ on some pre-defined criteria being met. In the case of this transaction Swiss Re would benefit from the capital if the notes it sold were triggered by a drop in the reinsurers solvency ratio.

In this way contingent capital is similar to a catastrophe bond, it provides capital when a triggering event occurs. Except of course a contingent capital bond is not insurance or reinsurance and so is accounted for differently. It provides another tool which insurers and reinsurers can use to secure themselves an additional source of capital, of course depending on the acceptance of investors in the capital markets.

In Swiss Re’s case investors were very accepting and snapped up $750m of contingent notes in this deal. Ratings agency Fitch has now rated the notes, which it is calling contingent write-off notes as the notes are written off and payout in full on a trigger event occurring, and has given them a rating of ‘BBB+’.

The rating announcement gives us a little more detail on the contingent bond issuance which was not available before. The notes are first callable in 2019, up to which point they pay investors a fixed annual coupon of 6.375%. The interest rate would then reset to the five-year mid-swap rate plus 5.21%. According to Fitch the notes are subordinated to senior creditors and there is an optional interest deferral facility depending on certain conditions with any deferred interest being cumulative.

Fitch said it has rated the contingent notes three notches below Swiss Re’s ‘A+’ Issuer Default Rating, in accordance with its insurance rating methodology.

Fitch explained; “For Swiss Re’s contingent write-off notes, Fitch has notched once for recovery expectations (Below Average) and then deducted a further two notches for going concern loss absorption features, which are deemed to be more aggressive, due to the presence of the write-off feature. Loss absorption is considered to be more punitive than recovery, given that principal write-off could occur at a point when Swiss Re continues to be viewed as a going concern.”

Interestingly Fitch gives us some more details on the trigger than we had previously. Full principal write-off would be triggered if Swiss Re’s solvency, as measured by the Swiss Solvency Test (SST), falls below 125%. At fiscal year 2012 Swiss Re’s SST stood at 207%, at fiscal year 2011 it was slightly higher at 210%.

Fitch said that the $750m of rated contingent write-off notes have been deemed to have a low trigger given the SST level for Swiss Re currently being high.

It’s an interesting transaction which would help Swiss Re should it face a major financial hit from anything which affected its solvency level. This could include catastrophe events, reinsurance losses, pandemics and even the fall-out of Eurozone financial issues or other global economic impacts. Literally any event that could cause Swiss Re’s solvency level to drop dramatically is in effect covered to some degree by the capital buffer this contingent capital transaction provides. Whether a $750m capital buffer would actually be sufficient to protect the firm should Swiss Re’s solvency drop quite so far as to trigger it is another issue entirely.

Souce: Artemis.bm

CoCos and their risks

CoCo evolution poses "Catastrophic" issues

Posted  Monday, 4 March 2013, 9:24 GMT

By  Aimee Donnellan / thomsonreuter

* Swiss Re pushes boundaries on CoCos
* Total-loss feature raises concerns about unquantifiable risks
* Investors divided on CoCo future 

By Aimee Donnellan
LONDON, March 1 (IFR) - Swiss Re's plan to sell the first total-loss contingent convertible instrument from a reinsurer has drawn parallels between the product and catastrophe bonds, and prompted concerns that investors might misjudge the risks they are taking. 

Swiss Re was the first to test CoCos from the insurance and reinsurance industry when it sold a deal with a more investor-friendly equity conversion structure last January, and the incentive for it to do more is clear. 

Compared with traditional cat bonds, CoCos not only offer longer duration and larger sized deals, but also provide access to a more diverse investor base - one that banks such as Barclays and KBC have already taken advantage of to issue permanent write-down deals. 

CoCos are also a useful tool for reinsurers seeking to cover their risks effectively. 

"CoCos arguably offer more flexibility than a catastrophe bond by covering losses across an insurer's portfolio of insurance and asset risks rather than one or a few specified perils," said Daniel Bell, head of EMEA DCM capital products at Bank of America Merrill Lynch.  

"I don't think CoCos will replace cat bonds, but they might make a good supplement." 

For investors, however, the fact that potential losses are linked to Swiss Re's whole business rather than a single event, or a handful of events, as in the case of a cat bond, makes for a more complicated picture. Some experts fear that investors may fail to assess the risks adequately. 

"The catastrophe bond world is very specific and investors tend to be very well versed on the risks they are taking. With CoCos it's about the whole capital structure of an issuer, which can be more difficult to analyse," said a London-based capital hybrid banker. 

Although it is rare for a catastrophe bond to be wiped out, with only eight of around 210 property deals issued since 1997 having been triggered, CoCos have no such track record.
   
SWEPT AWAY
The market rally that has driven spreads on many FIG bonds hundreds of basis points tighter since last summer has forced investors into riskier instruments, and it is easy to understand the attraction of CoCos in this type of current low-yield environment. 

Belgium's KBC and the UK's Barclays offered yields of 8 percent and 7.62 percent respectively on their CoCos. 

Swiss Re, the world's second-largest reinsurer, is coming to the end of an investor roadshow this week, having mandated Bank of America Merrill Lynch, BNP Paribas, Credit Suisse, HSBC and RBS as lead managers. 

Despite the aggressive structure, investors are showing a lot of interest - although they have some concerns about the deteriorating market, according to bankers on the deal. 

The high credit ratings of Swiss Re, at A1/AA-/A+, are also likely to provide some comfort to investors, particularly as they are at a similar level to Australian banks, considered to be among the safest banks on a global basis. 

Swiss Re also has a strong track record of repaying securities at first call. 

"If you are comfortable with the overall capital level and rating of an insurance company, and the trigger is low, it can make sense to buy into them," said Dierk Brandenburg, a senior bank credit analyst at Fidelity. 

Swiss Re, however, is expected to include a high trigger. In addition, there are some concerns about the reinsurance business as a whole, which covers claims on catastrophes such as floods, hurricanes and earthquakes that the ordinary insurance market is unwilling to take on because of the unknown nature of those types of events. 

Reinsurance companies have also been left badly burnt by some investment decisions in the past. In 2007, Swiss Re reported a shock $1.07bn write-down due to the sub-prime crisis. The losses stemmed from protection that Swiss Re sold to a client against a fall in the value of a portfolio. 

With the potential for unexpected losses like this, it might not take much to go wrong to reach the conversion trigger.
   
DIVIDED INVESTORS
Investors are aware of these concerns, but have been more willing to buy into insurance and reinsurance companies than banks over the past year. 

Insurance companies' minimal reliance on capital markets has been one of the factors behind their resilience to the financial crisis, analysts say. That stands in sharp contrast to banks that have needed to meet higher capital requirements from January 1 2013 as they grapple with the potentially damaging effect of proposed resolution regimes. 

On this point, investors seem divided on CoCos, as some say they are focusing on ratings, triggers and overall capital, while others want to be paid handsomely for the risk. 

"There are still a number of institutional investors that have a tough time with permanent write-down features and they will always drive spread conversations for that reason," said a London-based hybrid capital banker.

Swiss Re plans a new contingent bonds issuance

Published February 21, 2013

Dow Jones Newswires

Swiss Reinsurance Company Ltd (SSREY) plans to hold a series of investor meetings before launching a so-called contingent capital bond transaction, one of the banks mandated to arrange the roadshow said Thursday.

Contingent capital bonds, or CoCos, is debt that converts into equity, or loses its value, if the financial institution issuing it breaches a predetermined level of capital. This type of security is riskier for investors than more typical bonds but has higher returns.

CoCos provide financial institutions with an extra funding cushion, helping them to reach adequate reserve capital levels as required by worldwide regulation.

Bank of America Merrill Lynch, BNP Paribas, Credit Suisse, HSBC and Royal Bank of Scotland will be arranging investor meetings for Swiss Re.

Write to Serena Ruffoni at serena.ruffoni@dowjones.com

Copyright © 2013 Dow Jones Newswires

Source: http://www.foxbusiness.com/news/2013/02/21/swiss-re-plans-investors-meetings-for-contingent-capital-bond/#ixzz2LsRgEwr4

KBC: A new issuance of Contingent Capital Bonds in the Market

• E

KBC Groep NV (KBC), Belgium’s biggest bank and insurer by market value, plans to sell high-risk capital bonds similar to Barclays Plc’s recent deal that bankers said garnered more than $17 billion of orders.

The 10-year dollar-denominated notes will be written off if KBC has losses that reduce its so-called core Tier 1 capital ratio to 7 percent of assets or lower, according to an investor presentation obtained by Bloomberg News. The Brussels-based lender has capital of 12.7 percent of assets, according to the presentation.

Issuers of debt designed to take losses include Rabobank Groep NV, UBS AG, as well as Barclays, which in November sold $3 billion of bonds that will be written off if capital ratios fall to less than 7 percent. Bonds designed to absorb losses prior to a lender’s collapse are a child of the 2008 financial-sector crisis, when debt investors were repaid while taxpayer cash was used to prop up banks to safeguard the wider economy.

“The idea is to provide both senior creditors and shareholders with an extra layer of protection and enhance the stability of the bank,” said Paul Smillie, a Singapore-based global banking analyst at Threadneedle Asset Management, which oversees about $45 billion of fixed-income securities. “This is a carbon copy of the Barclays deal.”

KBC, which received Belgian bank-rescue funds three times to cushion against declines in the value of collateralized debt obligations and MBIA Inc. (MBI) insurance coverage of credit risk, is raising money to repay its bailouts. Management also has committed to retaining a Tier 1 ratio of at least 10 percent.

‘Divesting Assets’

KBC spokeswoman Viviane Huybrecht didn’t respond to a call seeking comment.

“That will make it one of the best-capitalized banks in Europe,” said Smillie. “KBC has been divesting assets and deleveraging for quite some time now.”

By selling the Tier 2 bonds in dollars, KBC can appeal to wealthy Asian investors in Hong Kongand Singapore seeking higher-yielding securities.

Standard & Poor’s said today it assigned a BB+ rating, the highest speculative grade, to the proposed securities. The bonds’ equity content is “minimal” and they are designed to allow the lender to continue to operate as a going concern as it seeks to raise money after they are triggered, S&P said.

Barclays (BARC) 7.625 percent contingent capital notes received a BBB- rating from S&P, one step higher than the KBC securities, and were priced to yield 604 basis points more than the benchmark Treasury bond. They now yield 537 basis points more than the 1.625 percent Treasury due 2022.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong atparmstrong10@bloomberg.net

Methodologies to price ILW as binary options

LONDON, Feb 4 (Reuters) – Industry Loss Warranties should be treated as binary options and use capital market methodology to price the contracts in order to attract a new “new breed of trader”, according to a paper. “The Industry Loss Warranty marketplace requires a more transparent and consistent method of determining forecast industry losses in order to provide an efficient means of pricing ILWs,” the paper, published by Hamish Raw on www.binaryoptions.com said.    The paper argues that both ILWs and binary options are structured to be either a fixed amount of compensation if the option expires in the money, or nothing at all if the option expires out of the money.. Souce: Mortimer, Sarah(Thompson Reuter, February 2013)