Tuesday 25 October 2016

Insurers seek succour from bond investors and Buffett

Warren Buffett and bond dealers are playing a key role in fixing the Irish insurance sector

Donal Griffin

Published 30/08/2015 | 02:30

Last month, health insurer VHI said Warren Buffett's Berkshire Hathaway granted it a subordinated loan
Last month, health insurer VHI said Warren Buffett's Berkshire Hathaway granted it a subordinated loan

Investors hunting for yield after a global financial rout might well take a detour to the headquarters of a tiny insurance company, hidden away along a highway in west Dublin.

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Last week, just as world markets cratered, troubled Irish insurance group FBD said it was weighing the sale of as much as €100m of subordinated bonds to bolster capital before new solvency rules come into place in January.

The company may have to pay a coupon of about 10pc as investor appetite for risky assets wanes, according to analysts at Merrion Capital and Cantor Fitzgerald.

"It will be an expensive issue," agrees Creditsights analyst Raymond Tam. "It should be able to meet interest payments, so it's a good way to solve the solvency position. There's a question over the appetite of investors to take such a small issue."

FBD is the latest insurer to turn to junior bond markets to meet tougher solvency rules. Insurers in Europe issued €31.5bn of subordinated debt instruments last year and about another $10.6bn in the first half of 2015, according to analysts at Bloomberg Intelligence. Last month, health insurer VHI said Warren Buffett's Berkshire Hathaway granted it a subordinated loan.

For investors, yields on such debt can be attractive - compared with those linked to sovereign debt. The yield on Irish 10-year bonds plunged to 1.35pc from 14.2pc in July 2011, as we exited the Troika bailout and the ECB quantitative easing program came into play.

An FBD subordinated bond may have to carry an interest rate of about 9pc, according to Cantor analyst Fiona Hayes. That would be the second-highest coupon for a subordinated bond issued by a European insurance company so far this year, according to Bloomberg. Only securities sold by CIS General Insurance, a UK firm owned by Co-operative Group, carry a higher rate.

FBD may have to pay an interest rate somewhere between the "high single digits and low double-digits,'' according to Merrion bond trader Liam Dunne. That reflects the problems facing the Irish insurance industry in general and FBD in particular, he said.

FBD, based in an industrial estate on one of the main roads leading out of Dublin, started out selling insurance to Irish farmers about 40 years ago. The company is being hit by increasing claims after it expanded to offer products such as motor insurance to urban clients. Last week, Fiona Muldoon, who was appointed interim chief executive officer last month, said that - in common with its rivals - the company hadn't charged enough for its policies.

With FBD shares tumbling, Muldoon said the company is weighing a bond sale of between €50m to €100m before the end of the year. Under the impending rules, European insurers can count subordinated debt as part of its own capital buffers against potential losses.

For companies like FBD, the advantage of selling bonds is that they can sidestep share sales - which would immediately hit existing investors. The downside for the company is a hefty interest rate, which may rise still further if investors continue to shy away from risky assets.

Insurers' subordinated bonds have fallen 5.4pc since the end of February. Debts sold by European governments with the highest credit rating and investment-grade corporate bonds have fallen by less than 2.4pc for the same period.

Last month, Berkshire Hathaway gave VHI a €90m subordinated loan, pushing the company's total capital reserves to more than €540m.

"There are more investors interested in this kind of product, providing capital to insurance companies," said Oliver Tattan, who runs Insurance Regulatory Capital, which invests in insurers' subordinated debt.

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