Nationwide debuts a new debt structure

admin | November 15, 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.

Nationwide recently (NATMUT) issued a new 30-year note which utilized a seldom seen layer of the insurance company capital structure. The notes were issued out of the holding company, Nationwide Financial Services Inc. (NFS), but with a guarantee from its P&C insurance operating company, Nationwide Mutual Insurance Co. The insurance company’s regulators must sign off on this type of OpCo debt guarantee, making it unlikely that NATMUT’s issuance will be the start of a major trend in the industry. Other issuers could follow, but this structure is probably a limited experiment by an issuer in good standing/liquidity, with a little more flexibility to tap a cheaper coupon – assuming investors treat the paper properly within the cap structure.

Note details

The new notes were issued with a senior rating of A2/A by Moody’s and S&P, which is one notch below the operating companies’ insurance financial strength (IFS) ratings of A1/A+. The deal seemed larger than expected, as NATMUT wound up pricing $1 billion at a launch level of +162 vs initial price talk (IPT) of +180-185.  A large portion of the $600 million proceeds will be used to repay debt maturing in 2021, which incidentally is more traditional senior holding company debt.

Comparison to traditional insurance company debt structures

Insurance companies – particularly life and multi-line issuers, like NATMUT – typically issue in three possible structures:

1. Senior holding company debt, which is typically rated three notches below the IFS rating;
2. Secured notes, or funding agreement (FA) backed structures, frequently referred to as guaranteed investment contract (GIC) backed notes – typically rated in-line with the IFS rating; and
3. Subordinated hybrid “surplus notes” – typically rated two notches below the IFS  by the major rating agencies.

There are some remaining junior subordinated notes still outstanding for a few issuers in the sector, but there is very little capital incentive for this tranche to continue being a viable source of funding for the insurers. There are several highlighted in orange (Exhibit 1).

The new notes from NATMUT have a guarantee at the insurance operating company level (rated one notch below the IFS), meaning they are subordinated only policyholders. The most senior level debt issues are the GIC (FA-backed) structures (rated at the IFS), since the GIC structure sets up a specific trust to meet the debt obligations at the operating company level, which puts them pari passu to policyholders in the eyes of the rating agencies. We have always been a little skeptical that bondholders would get paid ahead of the actual insured—particularly at the mutual companies, which are run solely for the members—but either way, that is the key distinction that results in the one notch lower rating on the new NATMUT 30-years.

Relative value

The NATMUT 3.9% ’49s launched at +162 to the 30-year, coming 20-25 bp tighter than IPT. The bonds traded a few basis points tighter on the break with current indications wrapped around +160. Given the large size of the deal it is no surprise where valuation landed, with NATMUT ’44 senior HoldCo notes (Baa1/BBB+) at around +210 to the curve, while the higher-rated, but structurally senior NATMUT ’44 surplus notes (A3/A-) are closer to +180. Insurance companies do not typically issue GIC-backed notes longer than 10-year maturities, as issuance even longer than 5-years is pretty sparse; therefore there are no true senior OpCo obligations to compare the NATMUT ‘49s in that part of the curve. Valuation as tight as the +140 range seems very justifiable, but may be inhibited again by the large deal size and the absence of appropriate structural comps.

 Exhibit 1: Life and multi-line insurance – various debt structures

Source: Amherst Pierpont, Bloomberg/TRACE G-Spread – Indications Only

There is typically good value seen among surplus notes, particularly for mutual companies that have little or no debt outstanding at the holding company, and therefore little to subordinate these hybrid structures. Those liquidity discounts have compressed over time, particularly as new issuance in surplus notes over the past several years provided price discovery and enhanced coverage of this once dormant debt tranche. Most of the sector now prices closer to fair value versus senior holding company and secured instruments. Like the new guaranteed structure employed by NATMUT, surplus notes also have a regulatory element, as the “hybrid” status comes from the requirement that regulators approve the coupons annually. No investment grade surplus note has ever had its coupon withheld by regulators since their original inception in the early-to-mid-1990s.