Late last week, Swiss Re announced that the company would be redeeming its Australian dollar legacy Tier 1 hybrids at the first opportunity on 25 May 2017. Both fixed and floating rate notes will be called
Swiss Re has long been a favoured FIIG trade, with the first recommendations made around eight years ago into both lines.
|Security description ||Call price |
|SWISSRE BBSW+1.17% 25May17c ||$100.00 |
|SWISSRE 7.635% 25May17c ||$100.00 |
Swiss Re has long been a favoured FIIG trade, with the first recommendations made around eight years ago, into both lines.
Swiss Re Tier 1 securities are debt like hybrids that were issued in 2007 with deferrable coupons and are technically perpetual, with a first call date in in May this year. Swiss Re Tier 1s were first identified by Research as an opportunity for clients in 2009, in the wake of the GFC. The first client purchase was at $53 for $3m at a yield to call of 19.44%.
From our May 2009 Research Report:
Tier 1 “deeply subordinated” bonds issued by SwissRe are considered a very attractive proposition. Due to the wave of European banks and insurance companies that have been forced to defer or cancel coupons on Tier 1 bonds over recent months, the entire sector has seen a significant blow-out in spreads. However, FIIG Research considers the risk of coupon deferral/cancellation to be low (less than 10%) whereas current trading levels would suggest the chances are close to 100%. Risk to principal is also considered minimal.
Since 2009, Swiss Re have found their way into portfolio recommendations regularly and more than one thousand FIIG clients have transacted almost $2 billion by face value with an average entry price of $90.65. It is a rare wholesale client who has not owned a Swiss Re security at some stage.
Where to reinvest?
With $450m and $300m outstanding in the fixed and floating rate issues respectively, investors will be seeking replacement securities. Given the wave of cash that is due to hit accounts, it is wise to consider selling the notes prior to maturity and reinvesting now if a suitable replacement is available. By waiting, an investor limits their reinvestment opportunities to bonds available at maturity. This task may be made more difficult by the sheer size of the transactions. Although, a seller will give up the remaining days of interest on the securities, they will receive accrued interest for the days held. If the replacement has a higher running yield, income focussed investors will not miss out.
In our view, bank and insurance subordinated bonds are the best replacements given the maturing exposure and there are quite a number of these available with trading margins from 1M BBSW +0.90% to +2.00%. See the graph below.
Source: FIIG Securities
Indicative ask pricing, financial/insurance subordinated debt
All investors have something to gain from the Swiss Re experience:
- Regulatory capital instruments have changed substantially over the last few years, with a tendency to become more complex. Investors should be careful of both equity like and debt like hybrids and be familiar with the terms and conditions. Even where a default is unlikely, more junior ranking securities are more likely to be more volatile due to coupon deferability, uncertain redemptions, and equity convertibility
- Times of crisis and volatility sometimes mark heightened opportunity. What is an attractive rate of return today will be even more attractive if the securities trade at a sizeable discount
Our research team continues to monitor the fixed income universe for opportunities like Swiss Re, rare as they are, and we hope that our reports and The WIRE assist you in identifying them.
This is also an excellent opportunity to review portfolios and rebalance if necessary. All holders should contact their dealer or visit MyFIIG to download their Portfolio performance report.