Precapitalized securities offer attractive spreads over comparable senior notes
admin | April 23, 2021
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.
Precapitalized securities or P-CAPs are a unique trust structure utilized by insurance companies seeking to issue debt, but also wanting to keep leverage off the balance sheet until or if the funds are eventually needed. The bonds trade in the secondary market at a sizable discount to comparable senior unsecured debt issued by the same insurance companies. Investors are well compensated for the moderate give-up in liquidity and structural implications associated with these securities.
Some examples of P-CAPs in the insurance industry include: Prudential Financial’s (PRU: A3/A/A-) Five Corners Funding Trust, Equitable Holdings’ (EQH: Baa2/BBB+) Pine Street Trust, Voya Financial’s (VOYA: Baa2/BBB+) Peachtree Funding Trust, and the more recent Belrose Funding Trust issued by Lincoln National (LNC: Baa1/A-/A-) and High Street Funding Trust issued by Principal Financial Group (PFG: Baa1/A-/A-).
Exhibit 1. P-CAPs vs senior unsecured
Source: Bloomberg/TRACE – BVAL Indications Only
The motivational concept behind a P-CAP is fairly simple. The issuer creates a trust that accesses the public debt market, but that debt is held off balance sheet of the insurance company and does not contribute to financial leverage. The proceeds of the securities issued by the trust are used to purchase Treasuries (principal or interest strips), from which the trust will pay a coupon plus a locked in spread rate that is paid/provided by the underlying insurance company. In effect, it is a means for an insurance issuer to essentially lock in or create an option on interest rates at a time when they view rates as attractive but might not necessarily need to issue debt. The company has a put option to issue senior unsecured debt into the trust at any time and take ownership of the treasury securities that are held (typically at increments of $50 or $100 million depending on the terms of the deal). Only at that point does the debt count toward financial leverage and the issuer have access to the funds.
All outstanding P-CAPs are rated in-line with the senior unsecured debt, as the rating agencies view the credit quality as being closely linked to that of underlying insurance company. The notes issued into the trust upon exercise would be pari passu with all senior unsecured debt obligations of the underlying insurance company. An issuer would choose to execute voluntarily in the event that it could no longer access the public debt markets or simply views current rates as unattractive to issue new debt. Debt issuance to the trust can also occur as a result of a mandatory exercise event, which we describe below. So far, no insurance company that has issued P-CAPs has ever exercised either voluntarily or through automatic/mandatory action.
Exhibit 2. Examples of P-CAPs vs senior unsecured
Source: Bloomberg/TRACE – BVAL Indications Only
An automatic exercise event occurs if either a bankruptcy event occurs at the underly insurance company, or if the company fails to make scheduled payments to the trust. A mandatory exercise event would occur if consolidated net worth of the company falls below a certain threshold, or if the company defaults on other payments or violates debt covenants. In either case, the senior debt then issued to the trust puts holders of the P-CAPs in a pari passu position with other senior debtholders of the insurance company.
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