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Strong earnings spark recovery rally for insurance companies

admin | February 14, 2020

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.

Insurance companies have been reporting solid 4Q19 numbers—spurred in part by the bull market in equities that closed out the year— helping to fuel a relief rally in corporate bonds led by the higher beta credits within the sector. Brighthouse Financial (BHF) and American International Group (AIG) are leading the push tighter in the life insurance and property and casualty (P&C) segments, respectively. Investors should continue to build positions in BHF, where the issuer’s steep curve favors long bonds; but limited upside in AIG should encourage migration to outlier credits in the P&C space.

Bottom-line: Prior to yesterday’s recovery, AIG bonds have produced -1.54% excess return year-to-date. That compares with the top-20 issuer excess return of +12.1% (+20.4% total return) generated in F2019. Similarly, BHF bonds had generated -1.38% year-to-date excess returns prior to yesterday’s price move, compared with a top-5 issuer excess return of +16.3% (+26.0% total return) in F2019. AIG long bonds recently closed about -5 bp tighter off the local wides. BHF 2027s and 2047s, which we have written about previously (APS Strategy – BHF 30yr), were both about -10 bp tighter over the past two sessions. Investors should continue to position BHF bonds assertively, particularly the long bond 30-years, due to steepness of the issuer curve (Exhibit 1) and absolute levels that still insulate investors to potential longer-term credit downside. AIG bonds (Exhibit 2) are now trading at levels that offer limited near-term upside to the rest of the sector, but represent solid overall yield relative to the broader bank/financial sector. Investors should consider more actively targeting outlier credits within the P&C segment, such as AIZ (‘28s, ‘30s) and FFHCN.

Exhibit 1: BBB Life insurance paper – senior unsecured

Source: Bloomberg/TRACE indications only, Amherst Pierpont Securities

Brighthouse Financial (BHF: Baa3/BBB+/BBB): BHF’s results were extremely well-received by the equity market, as the share price spiked +15% in response to the announcement. The reaction was mostly due to positive developments in capital and the fact that they went right ahead with fairly aggressive share repurchases as profitability permitted. The big line items were the increase in capital measures (statutory total capital to $9.7 billion from $7.4 billion the prior year), the fact that reported profits doubled vs last 4Q (EPS $2.46), and again the repurchases ($500 million in additional repurchase authorization, on top of $600 million existing; $570 million repurchased since 2018). Notably on an adjusted GAAP basis they would have posted a $1.077 billion loss due to accounting changes impacting BHF’s derivatives portfolio. The quarterly results demonstrate good operating momentum, as equity markets maintain forward trajectory. Sales of their core products looked strong, and the capital increase of course is good for credit. Bondholders should be a little wary of how quick management has been to implement repurchases, as it doesn’t provide much flexibility for credit improvement if that continues to be their priority. Still, the main takeaways here are positive for both BHF equity and bondholders coming out of a fairly convincing 4Q19.

Exhibit 2: BBB P&C insurance curve – senior unsecured

Source: Bloomberg/TRACE indications, Amherst Pierpont Securities

American International Group (AIG: Baa1/BBB+/BBB+): AIG reported EPS of $1.03 beating the $0.99 consensus estimate. Most impressively, AIG met a key performance goal by booking an underwriting profit, with a combined ratio (all in underwriting costs to revenue) under 100% for the first time since 2007. CEO Deuperreault’s—in place since 2017—turnaround efforts are finally beginning to deliver on promises set over his tenure. To be fair, the business environment has been very helpful with low catastrophe losses helping drive profitability in 2019. For bondholders, success on the revitalization front over the past few years has significantly cooled investor calls to dramatically restructure AIG in the form of a split or spin-off of its multi-line insurance businesses, which would have unknown impacts to creditors. AIG also announced that they would be redeeming their $350 million AIG 4.35% ’45 euro-dollar notes on 03/20/20, which could suggest some issuance as they exit their earnings blackout period.

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