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Corporate credit: Equity volatility sets up opportunity in insurers
admin | May 24, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Weak performance in equities historically leads to wider spreads on insurers, and that has been the case lately for ‘BBB’ issuers. Sellers have outnumbered buyers in that niche, creating opportunity to add paper with potential to tighten in the long run.
Weak equities, wider spreads on insurers
Insurers usually widen as equity falls for a pair of reasons: First, equity sell-offs often coincide with a rally in UST; therefore, long duration sectors within the IG corporate index such as life insurance will then frequently see wider moves in OAS to offset the move in the long-end of the curve. Second, persistent weakness in stock performance threatens operating results in the sector, particularly for life insurers with notable exposure to variable annuities. Whether these operating risks are real or perceived, investors commonly react to weakness in equities by reducing allocation or scaling back risk in the insurance sector.
Domestic equities have dipped 4% month-to-date, following a roughly 20% rally year-to-date through April. So far, the statistical performance in the insurance sectors has not stood out in terms of weakness. Compared to the Bloomberg Barclays Corporate Aggregate Index, the life insurance segment has produced a -0.56%* excess return (vs UST) on about 4 bp to 5 bp of aggregate spread widening month-to-date, which is only marginally worse than the -0.44% produced by broad financials on about 7 bp to 8 bp of aggregate spread widening. The P&C segment has produced a -0.52% excess return for May. Neither is materially worse than the -0.72% for the IG Index, as energy and materials have been hardest hit in the recent back-up in credit.
At the end of April, YTD excess return for the life insurance sector was 5.42% compared to 3.33% for broad financials and 3.67% for the IG index. Total return for life insurers was 7.68% compared to 5.71% for the index. P&C had produced a more even market performance with excess return of 3.00% and total return of 5.14%
The statistical performance for the insurance segments does not necessarily reflect the ongoing reality in credit markets. This is due in part to the high concentration among some of the most stable and safe credits within the Index, such as MET and PRU for Life Insurance and Progressive for P&C. This blurs the weakness that is more evident in the smaller and lower-rated credits within those segments. More anecdotally, sellers have outnumbered buyers for ‘BBB’ insurance paper. This is causing actionable spread levels to back up and create potential buy opportunities within the sector. Investors can use temporary dislocation to selectively add ‘BBB’ insurance exposure with longer-term potential for spread tightening.
Relative value
One opportunity in lower-rated insurers is in Assurant Inc. (AIZ: Baa3/BBB) longer-dated paper, AIZ 6.75% 02/15/34 (04621XAD0). At an offered spread of 272 bp (G + 262 bp), bonds provide more spread than any other issue at any other point on the ‘BBB’ P&C curve (Exhibit 1). These bonds are offering a total yield of 5.04%, which looks like more than adequate compensation for high dollar price and high coupon. These bonds have outperformed the peer group over the past six months, but still appear to have room to run.
Exhibit 1: AIZ 34s relative to comparable ‘BBB’
Source: Amherst Pierpont, Bloomberg/TRACE Indications
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