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Unprecedented Boom in RT1 Bonds: Investors Embrace Insurance Market's New Darling


Robert Tavares

March 20, 2024 - 12:20 pm


Surging Demand for Insurance Debt: The Rise of RT1 Bonds

A surge in the insurance bond market

As the landscape of European financial markets evolves, investors are increasingly flocking to an obscure corner of the insurance bond market. This niche, bearing resemblances to the banking sector's Additional Tier 1 securities, is witnessing a remarkable uptick in activity. Specifically, Restricted Tier 1 (RT1) notes are the instruments capturing the market's attention as insurers gear up to meet imminent regulatory deadlines. This shift promises a significant spike in the supply of these bonds in the upcoming year.

In a notable display of confidence, Dutch insurer ASR Nederland NV successfully tapped into investor demand through its Restricted Tier 1 note offering. The bond sale today successfully garnered over €1.5 billion in orders for a €500 million issuance. A person familiar with the matter, preferring to remain anonymous, highlighted the robust demand that exceeded the original offering threefold. This latest offering marks the third RT1 transaction in a major currency for the year, setting a precedent as the quickest pace of issuance to date. It follows on the heels of highly sought-after sales by major players such as AXA SA and NN Group NV, with AXA's recent €1.5 billion sale breaking records as the largest RT1 deal to date.

These RT1 sales have become particularly attractive to investors due to their higher yield proposition relative to more conservative debt types. Furthermore, they are underpinned by the robust capital structures of insurers, offering a degree of reassurance. The timing for this burgeoning demand aligns perfectly with the needs of European insurance companies. A plethora of aging bonds are approaching a critical point where they will no longer align with the post-financial crisis regulatory frameworks, specifically necessitating a refresh in capital instruments.

"Institutional investors have demonstrated a zealous appetite for insurance debt. The recent issuances of RT1 and senior notes have been met with overwhelming subscription rates," remarked Marcos Alvarez, the managing director of global insurance ratings at Morningstar DBRS. Alvarez anticipates this trend of strong demand for insurance sector debt to persist.

The impetus behind the quickened pace of RT1 offerings can be traced back to the culmination of a grace period awarded to European insurers in the aftermath of new regulations. Solvency II, designed to fortify the sector, rendered certain older forms of junior bonds incompatible as capital, setting the end of 2025 as the deadline to phase them out. The introduction of RT1 notes in 2017 emerged as a new means of capital conservation, closely mirroring the function of AT1s within banking institutions.

Following their respective RT1 issuances, both AXA and NN Group took proactive steps to manage their legacy bond portfolios. They initiated buybacks or opted for early repayments of heritage bonds. Likewise, ASR is exploring similar strategies to repurchase bonds issued over a decade prior.

Despite their similarities with banking AT1s, RT1s are still relatively under the radar. Both are perpetual, with the ability to defer interest payments, and obligate holders to incur losses through principal reductions or equity conversions in scenarios where regulatory capital dips below specific benchmarks—commonly under the 75% threshold. Nonetheless, RT1s command a mere fraction of the market size when compared to AT1s based on data amassed by Bloomberg. Moreover, RT1s have managed to avoid the limelight of dramatic events, such as the notable erasure of $17 billion worth of Credit Suisse bonds witnessed a year ago.

For investors specializing in financial sector credit who traditionally focus on AT1s, the allure of insurer RT1s lies in their diversification benefits. As Filippo Alloatti, head of financials in the credit team at Federated Hermes explains, RT1s may offer reduced volatility in comparison to their banking counterparts, particularly when banks face distress.

Insurers themselves have a vested interest in issuing new RT1s. Several of their vintage bonds are structured with step-up interest payment features, and there is a historical precedent of such bonds typically being called in.

It is important to note that insurers possess the flexibility to blend different varieties of junior debt within regulatory confines. Consequently, not every antiquated note will be replaced by an RT1. In previous replacement cycles for grandfathered bonds last year, insurers opted for Tier 2 bonds instead—these are categorized as senior to RT1s.

Despite the variety of options available, the components are aligning for what may be a standout year for the RT1 supply. "This year has unveiled a favorable milieu for European financial entities to reengage with the market," indicated Morningstar's Alvarez. He regards the Solvency II transition as a pivotal juncture that will propel more European insurers into taking preemptive actions.

In conclusion, the insurance debt market is on the verge of a transformation. As regulatory deadlines loom, European insurers are pressured to align their capital structures accordingly. The RT1 market responds to this pressure, offering both investors and insurers avenues to satisfy their respective needs—yield and regulatory compliance. As RT1s gain traction, they not only contribute to the reshaping of insurer capital; they also present new opportunities and considerations for market participants worldwide.

For further reading on the topic, read the Netherlands report on potentially ending AT1s after the Credit Suisse upheaval.

The approaching $23 billion deadline for insurers to buy back junior debt is also a significant event to monitor. More details are available here.

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