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Downside risk limited in Brighthouse 30-year paper
admin | September 27, 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.
As investment grade spreads have moved tighter over the past several years, the gap between broad IG corporates and IG insurance has narrowed – indicating that investors can rotate more allocation into the sector at a lower give-up in spread than has traditionally been required.
Exhibit 1: IG index OAS vs IG insurance OAS – 5-year trend
Source: Bloomberg Barclays IG indices, Amherst Pierpont Securities
Even as overall corporate spreads have rallied year-to-date in higher beta issuers/sectors, Brighthouse Financial (BHF:Baa3/BBB+/BBB) continues to trade with the most spread in all of the IG life space – and arguably among the highest in broad financial senior paper. While some of the negative perceptions about the credit are warranted, the risk premium on the name sufficiently compensates investors for the reasonable downside in valuation. Bonds offer a roughly ~90 bp pick to closest peer EQH (Baa2/BBB+), which has a somewhat comparable risk profile.
Exhibit 2: IG life insurance 10- to 30-year paper, senior unsecured
Source: Bloomberg/TRACE indications, Amherst Pierpont Securities
Although there are limited 30-year bonds outstanding to substantiate, Bloomberg fair value curves for high yield 30-year paper—whether single B or BB, industrial or financial—all indicate that BHF ‘47s are already trading very close to where the market would likely value a crossover or BB-rated issue with a comparable credit profile. While we do not expect BHF spreads to improve materially relative to the rest of the life insurance sector in the near-term, the downside trading risk appears limited, while the available yield for a BBB IG issuer (>5.3%) remains too compelling to ignore.
Exhibit 3: USD spread curves – BHF vs broad financials (B, BB, BBB)
Source: Bloomberg/TRACE indications, Amherst Pierpont Securities
Risks associated with BHF credit have been well documented since it was first spun out of MetLife and issued debt for the first time in 2017. Perceptions are that the company is materially exposed to the double whammy of rate sensitivity and also being among the more sensitive credits within the IG life insurance segment to equity market volatility given BHF’s exposure to variable and fixed annuity product. An increasing percentage (the majority) of annuity sales are being generated through its newer flagship Shield suite of products, which a) are generating strong results among retail investors and b) have significantly less tail risk than some of the legacy products within the industry.
Other negative perceptions on BHF credit concern the valid disappointments of bondholders with management’s communication since its debut in the public debt markets. Specifically, the company saw capital levels weaken and overall credit quality deteriorate shortly after its initial offering. More recently, BHF management communicated a further slant to a more shareholder friendly posture – which they demonstrated through recent preferred and term loan issuance that helped fund their increased repurchase authority. On the positive side, this increase in leverage remained structurally subordinated to the long-term senior debt, but the negative reaction by bondholders is understandable. Nevertheless, even in a pessimistic scenario where cash flow deteriorates over the near-term—pushing leverage to non-IG levels—at current values investors’ downside is limited to the prospect of a downgrade to BB/crossover territory.
Exhibit 4: USD yield curves – BHF vs broad financials (B, BB, BBB)
Source: Bloomberg/TRACE indications, Amherst Pierpont Securities
Although there has not been a very long track record to cite for standalone BHF since it debuted in 2017, the company’s cash flow generation has been far more consistent than investors give them credit. BHF generated roughly $3 billion in free cash flow in 2017, 2018 and over the last twelve months.
Front-end liquidity also appears very strong. BHF’s first real senior debt maturity is the BHF 2027s ($1.5 billion). In the interim they have only about $1.1 billion in smaller term loan maturities thru ’24, for which they have a $1 billion revolver available, in addition to just under $4 billion in cash.
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