Fitch Affirms Phoenix Life & Phoenix Life Assurance; Outlook Positive
Fitch has also affirmed PGH Capital Public Limited Company's GBP300m 5.75% senior notes (XS1081768738) and GBP428m subordinated Tier 2 notes (XS1171593293) at 'BBB+' and 'BBB-', respectively. Both debt issues are guaranteed by Phoenix.
KEY RATING DRIVERS
The Positive Outlook reflects potential benefits from the proposed acquisition of Abbey Life (AL) from Deutsche Bank for GBP935m announced today, in addition to potential benefits from the previously announced acquisition of Embassy and Sun Life (ESL) from AXA UK for GBP375m (see 'Fitch Revises Phoenix Life's and Phoenix Life Assurance's Outlook to Positive' dated 27 May 2016 at www. fitchratings. com). Phoenix is financing the ESL acquisition through the issuance of GBP194m of new equity and via a bridge loan facility of up to GBP220m, which Phoenix plans to repay within six month of the ESL acquisition. Phoenix plans to finance the acquisition of AL through issuing GBP735m of additional equity and a new debt facility of up to GBP250m.
Fitch views both transactions as positive for Phoenix's market position and expects that the transactions will have a favourable impact on the company's capitalisation and financial leverage. Fitch expects that the ESL acquisition will accelerate the release of capital requirements due to increased diversification of life insurance risks because ESL has a higher proportion of mortality risk compared to longevity risk than Phoenix's existing business. The AL acquisition adds a well-capitalised insurance business to Phoenix's operations and Fitch expects Phoenix's Solvency II surplus to increase by GBP0.4bn due to the AL acquisition. AL currently faces conduct risk as a result of the FCA's review of 'fair treatment of long-standing customers' and the thematic review relating to annuity sales practices. However, Phoenix has agreed GBP175m indemnity protection with Deutsche Bank to cover potential negative outcomes.
The ratings reflect Phoenix's strong capitalisation and market position. These positive rating factors are offset by high, but significantly improved, financial leverage and fairly weak fixed-charge coverage.
We view Phoenix's capitalisation, as measured by our Prism factor-based capital model (Prism FBM), as "extremely strong" based on end-2015 data (end-2014: "very strong"). Phoenix's Solvency II coverage ratio was 122% at end-1H16 (end-2015: 130%). As the Solvency II ratio is dampened by the inclusion of own funds and solvency capital requirements of with-profit funds and the PGL staff pension schemes that are in surplus, Phoenix also reported the ratio excluding these effects, its "shareholder capital coverage" ratio, which was 144% at end-1H16 (end-2015: 154%).
Phoenix's financial leverage has improved significantly in recent years, to 29% at end-1H16 (end-2015: 31%) from 52% at end-2011. Fitch expects financial leverage to continue to improve in the medium term.
Phoenix's fixed-charge coverage was around 3x in 2015 and 1H16 (2014: around 6x), in line with the 2011-2015 average of around 4x, which is weak for the rating. The decline in 2015 was due to coverage in 2014 being supported by the proceeds of the sale of Phoenix's asset manager Ignis to Standard Life.
Phoenix is the largest consolidator of closed life assurance funds in the UK with total assets of GBP60.6bn (excluding reinsurance assets) at end-2015 and gross written premiums of GBP902m in 2015. However, as Phoenix's strategy is to acquire run-off portfolios only in the UK, the group's geographical diversification is limited. This exposes Phoenix to economic and regulatory changes in the UK.
Fitch expects Brexit to drive widespread credit pressure, as life insurers tend to be sensitive to deterioration of the market values of their assets. Sustained economic weakness leading to material deterioration in the market values of assets or lower demand for business could place UK insurers at risk of downgrades.
The ratings could be upgraded if Phoenix's score in Prism FBM remains "extremely strong" and financial leverage remains below 30% with Fitch expecting it to remain below 30% and evidence of successful integration of ESL and AL into Phoenix's operations.
We could revise the Outlook to Stable if the integration of ESL and AL into Phoenix's operation is not successful or if Prism FBM does not remain "extremely strong" or financial leverage does not remain below 30% in 2017.