* Swiss Re pushes boundaries on CoCos
* Total-loss feature raises concerns about unquantifiable
* Investors divided on CoCo future
By Aimee Donnellan
LONDON, March 1 (IFR) - Swiss Re's plan to sell the first
total-loss contingent convertible instrument from a reinsurer
has drawn parallels between the product and catastrophe bonds,
and prompted concerns that investors might misjudge the risks
they are taking.
Swiss Re was the first to test CoCos from the insurance and
reinsurance industry when it sold a deal with a more
investor-friendly equity conversion structure last January, and
the incentive for it to do more is clear.
Compared with traditional cat bonds, CoCos not only offer
longer duration and larger sized deals, but also provide access
to a more diverse investor base - one that banks such as
Barclays and KBC have already taken advantage of to issue
permanent write-down deals.
CoCos are also a useful tool for reinsurers seeking to cover
their risks effectively.
"CoCos arguably offer more flexibility than a catastrophe
bond by covering losses across an insurer's portfolio of
insurance and asset risks rather than one or a few specified
perils," said Daniel Bell, head of EMEA DCM capital products at
Bank of America Merrill Lynch.
"I don't think CoCos will replace cat bonds, but they might
make a good supplement."
For investors, however, the fact that potential losses are
linked to Swiss Re's whole business rather than a single event,
or a handful of events, as in the case of a cat bond, makes for
a more complicated picture. Some experts fear that investors may
fail to assess the risks adequately.
"The catastrophe bond world is very specific and investors
tend to be very well versed on the risks they are taking. With
CoCos it's about the whole capital structure of an issuer, which
can be more difficult to analyse," said a London-based capital
Although it is rare for a catastrophe bond to be wiped out,
with only eight of around 210 property deals issued since 1997
having been triggered, CoCos have no such track record.
The market rally that has driven spreads on many FIG bonds
hundreds of basis points tighter since last summer has forced
investors into riskier instruments, and it is easy to understand
the attraction of CoCos in this type of current low-yield
Belgium's KBC and the UK's Barclays offered yields of 8% and
7.625% respectively on their CoCos.
Swiss Re, the world's second-largest reinsurer, is coming to
the end of an investor roadshow this week, having mandated Bank
of America Merrill Lynch, BNP Paribas, Credit Suisse, HSBC and
RBS as lead managers.
Despite the aggressive structure, investors are showing a
lot of interest - although they have some concerns about the
deteriorating market, according to bankers on the deal.
The high credit ratings of Swiss Re, at A1/AA-/A+, are also
likely to provide some comfort to investors, particularly as
they are at a similar level to Australian banks, considered to
be among the safest banks on a global basis.
Swiss Re also has a strong track record of repaying
securities at first call.
"If you are comfortable with the overall capital level and
rating of an insurance company, and the trigger is low, it can
make sense to buy into them," said Dierk Brandenburg, a senior
bank credit analyst at Fidelity.
Swiss Re, however, is expected to include a high trigger. In
addition, there are some concerns about the reinsurance business
as a whole, which covers claims on catastrophes such as floods,
hurricanes and earthquakes that the ordinary insurance market is
unwilling to take on because of the unknown nature of those
types of events.
Reinsurance companies have also been left badly burnt by
some investment decisions in the past. In 2007, Swiss Re
reported a shock USD1.07bn write-down due to the sub-prime
crisis. The losses stemmed from protection that Swiss Re sold to
a client against a fall in the value of a portfolio.
With the potential for unexpected losses like this, it might
not take much to go wrong to reach the conversion trigger.
Investors are aware of these concerns, but have been more
willing to buy into insurance and reinsurance companies than
banks over the past year.
Insurance companies' minimal reliance on capital markets has
been one of the factors behind their resilience to the financial
crisis, analysts say. That stands in sharp contrast to banks
that have needed to meet higher capital requirements from
January 1 2013 as they grapple with the potentially damaging
effect of proposed resolution regimes.
On this point, investors seem divided on CoCos, as some say
they are focusing on ratings, triggers and overall capital,
while others want to be paid handsomely for the risk.
"There are still a number of institutional investors that
have a tough time with permanent write-down features and they
will always drive spread conversations for that reason," said a
London-based hybrid capital banker.