31.08.2016, 19:41
Fitch: More Insurer RT1s Ahead; Ratings Likely 5 Notches Off IFS
OREANDA-NEWS. Norwegian insurer, Gjensidige Forsikring's, issuance of a Restricted Tier 1 (RT1) bond reinforces our expectation that a market will develop in Europe for these innovative instruments, Fitch Ratings says. We did not rate the Gjensidige bond but our likely rating approach for RT1s would be to notch down from the Insurer Financial Strength (IFS) rating by five notches (four notches from the Issuer Default Rating/IDR). This would reflect both deep subordination and the potential for investors to suffer a loss while the insurer avoids a general default.
It is unclear how quickly the market for RT1s will grow or how big it will get, but there are several reasons insurers are likely to be interested in raising capital in this new form. In particular, RT1s are cheaper than issuing common stock, and their loss-absorbing features could help insurers manage volatility in their Solvency 2 coverage ratios. Under Solvency 2, at least 50% of insurers' solvency capital requirements must be covered by 'own funds' of the highest quality, known as Tier 1, and up to 20% of Tier 1 own funds can be RT1 instruments.
When rating insurance hybrid instruments, we look at two key aspects: the level of subordination and what that means for expected recoveries in a liquidation; and non-performance risk, which reflects the risk of investors facing a loss before a general default event for the issuer.
As far as subordination/recovery is concerned, since RT1s are deeply subordinated and are intended to be loss-absorbing, we would expect recoveries to be close to zero. Fitch would therefore notch down the maximum of two from the IDR for recovery.
For non-performance risk, notching is linked to the likelihood that any loss-absorption feature of the instrument is triggered. For RT1s, these features include mandatory coupon cancellation if the solvency capital requirement is breached, and forced conversion into equity or write-down of the instrument if capital levels remain low or fall further. Management must also have the right to cancel coupon payments at their discretion.
In most cases management discretion over coupons is likely to be the key feature driving the level of notching as this would probably be triggered before any mandatory conversion or write-down. Critical to this evaluation is our view on how much pressure regulators would exert on management to cancel coupons when stress emerges.
For the similar Additional Tier 1 (AT1) instruments with fully discretionary coupons issued by banks, Fitch's base case is to notch down by three notches from the Viability Rating for non-performance risk on the view that bank regulators will be assertive in pressing for cancelled coupons. It is harder to assess how aggressive insurance regulators will be in practice, but our judgment at the moment is that they will not be as assertive as their banking counterparts. We are therefore more likely to notch down insurance RT1s by two rather than three notches relative to the IDR for non-performance risk. However, expectations of regulatory behaviour could vary by jurisdiction and issuer.
An exception could be if an insurer included a significantly higher trigger for mandatory coupon cancellation and/or principal conversion or write-down than is required to qualify as an RT1. In this event we would be more likely to notch down three steps from the IDR for non-performance risk.
The typical extra notch between the IFS rating and typical RT1 rating is due to Fitch's practice of notching up the IFS rating by one from the IDR for an expectation of good recoveries for policyholders in most jurisdictions.
It is unclear how quickly the market for RT1s will grow or how big it will get, but there are several reasons insurers are likely to be interested in raising capital in this new form. In particular, RT1s are cheaper than issuing common stock, and their loss-absorbing features could help insurers manage volatility in their Solvency 2 coverage ratios. Under Solvency 2, at least 50% of insurers' solvency capital requirements must be covered by 'own funds' of the highest quality, known as Tier 1, and up to 20% of Tier 1 own funds can be RT1 instruments.
When rating insurance hybrid instruments, we look at two key aspects: the level of subordination and what that means for expected recoveries in a liquidation; and non-performance risk, which reflects the risk of investors facing a loss before a general default event for the issuer.
As far as subordination/recovery is concerned, since RT1s are deeply subordinated and are intended to be loss-absorbing, we would expect recoveries to be close to zero. Fitch would therefore notch down the maximum of two from the IDR for recovery.
For non-performance risk, notching is linked to the likelihood that any loss-absorption feature of the instrument is triggered. For RT1s, these features include mandatory coupon cancellation if the solvency capital requirement is breached, and forced conversion into equity or write-down of the instrument if capital levels remain low or fall further. Management must also have the right to cancel coupon payments at their discretion.
In most cases management discretion over coupons is likely to be the key feature driving the level of notching as this would probably be triggered before any mandatory conversion or write-down. Critical to this evaluation is our view on how much pressure regulators would exert on management to cancel coupons when stress emerges.
For the similar Additional Tier 1 (AT1) instruments with fully discretionary coupons issued by banks, Fitch's base case is to notch down by three notches from the Viability Rating for non-performance risk on the view that bank regulators will be assertive in pressing for cancelled coupons. It is harder to assess how aggressive insurance regulators will be in practice, but our judgment at the moment is that they will not be as assertive as their banking counterparts. We are therefore more likely to notch down insurance RT1s by two rather than three notches relative to the IDR for non-performance risk. However, expectations of regulatory behaviour could vary by jurisdiction and issuer.
An exception could be if an insurer included a significantly higher trigger for mandatory coupon cancellation and/or principal conversion or write-down than is required to qualify as an RT1. In this event we would be more likely to notch down three steps from the IDR for non-performance risk.
The typical extra notch between the IFS rating and typical RT1 rating is due to Fitch's practice of notching up the IFS rating by one from the IDR for an expectation of good recoveries for policyholders in most jurisdictions.
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