Credit Suisse fallout to trigger possible pause in RT1 bond issuance by insurers

The write-down of Credit Suisse Group AG's additional Tier 1 (AT1) bonds in March will make issuing or renewing the insurance equivalent of those bonds more costly in the short term.

In addition to knocking investor confidence in the AT1 market, Credit Suisse seeing the value of about CHF16 billion of its AT1s cut to zero has widened the spreads of insurer-issued restricted Tier 1 (RT1) bonds. Issuance of RT1 bonds is likely to come to a standstill for some months, industry observers said.

"If an insurer tried to come to the market in the next month or so, they would have to pay well into the double digits to get the issue away," Andrew Gillham, senior investment manager at Team Asset Management, said in an interview. "So that would put off a lot of insurers from doing so."

Cold market for summer

The market is unlikely to open for a new issue until after the summer, although one is possible if there is a period of calm, said Peter Doherty, head of fixed income at Sanlam Investments.

"We would probably need to see a bit more of the Credit Suisse process go through," Doherty said in an interview. "If you're not in a hurry to issue Tier 1, you might wait until later in the year."

Restoration of market confidence will be dictated in part by the AT1 market, as there are no upcoming first call dates for RT1s in 2023, according to Gillham. AT1s and RT1s are contingent convertible bonds, which either convert to equity or are written down if certain triggers are hit. They do not have maturity dates, although failing to redeem them on their first call dates can hit investor confidence. Some big banks, such as UniCredit SpA, have AT1s with a call date this year.

"If those banks call those AT1s on schedule, I think that will help restore confidence pretty quickly, whereas if one or two of them miss, obviously, it's going to cause another shakeout," Gillham said.

Asset managers are optimistic that market equilibrium will be restored soon, particularly because of the financial health of the insurance market in general.

"While over the short-term it has become more expensive for issuers to come to the market, we believe that over time this should normalize as fundamentals prevail," Romain Miginiac, fund manager and head of research at asset manager Atlanticomnium, said in an email.

Spot the difference

Insurers use RT1s as a source of regulatory capital under the EU's Solvency II regime, which came into force in 2016. Since they convert to equity, they are considered part of an insurer's Tier 1 capital, although there is a limit on how much Tier 1 capital can come from RT1s.

Many big-name European insurers make use of RT1s. UK insurer Aviva PLC joined their ranks with a £500 million issue in 2022.

While the RT1 market has been caught up in the Credit Suisse storm to a certain extent, it has been cushioned from its full impact. The RT1 spread movements have been "much more orderly" than those of AT1s, Miginiac said. RT1 spreads have widened less than 150 basis points since early February, compared with about 300 basis points for AT1s, he added.

The fate suffered by Credit Suisse AT1 holders is considered highly unlikely to be replicated in the insurance RT1 world. The write-down of Credit Suisse's AT1s was controversial because holders of those bonds lost their investments completely before common equity capital was exhausted, subverting the typical order that owners of a company's securities would suffer losses.

Terms of Credit Suisse's AT1s allowed them to be written down completely if there was a "viability event." This trigger was hit, according to Swiss financial regulator FINMA, when the Swiss government granted liquidity support to the bank.

The typical creditor hierarchy looks likely to be preserved for RT1s.

"While existing or developing resolution frameworks for insurers do or may confer regulators with the ability to impose losses on shareholders and bondholders if the insurer is deemed to fail, RT1s would absorb losses after shareholders," Miginiac said.

RT1s are typically triggered when an insurer's solvency ratio drops below a certain point and "not by liquidity considerations alone," Fitch Ratings said in a March 24 note.

Insurers are far less likely than banks to experience runs and the associated liquidity problems. While there can be mass surrenders of life insurance policies if customers lose confidence in an insurer, policyholders suffer penalties for exiting policies, and the process is far slower.

"It's a very different time frame to deposit liquidity risk," Doherty said. That gives insurers more time to take remedial action.

Tier 1 debt investors have started to notice the different risk profiles and price them in. Doherty said that before the Credit Suisse event, yields on AT1s and RT1s were broadly similar. However, "there has been a tiering now of pricing, which has been sadly absent."