The Long and Short

Harvesting liquidity discounts

Dan Bruzzo, CFA | November 3, 2023

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.

Liquidity has become more valuable across fixed income in the last few weeks, boosting the yield spread between corporate bonds eligible and ineligible for the investment grade index. That is clearly the case in the long end of the investment grade market, especially around the 20-year mark, which currently is the highest yielding part of most curves. Buy-and-hold investors can find good relative value opportunities in non-index eligible issues in that part of the curve.

The off-the-run, non-index 20-year bonds issued by AXIS Capital Holdings (AXS: Baa1/A-), as an example, are trading at a steep discount to comparable securities. Eligible bonds of similarly rated peers are trading approximately 40 bp tighter than AXS in that part of the curve. All else being equal, corporate bonds with a 20-year maturity typically provide a discount of 15 to 20 bp for a lack of index eligibility. A number of of comparable bonds trade at a premium and present swap opportunities relative to the AXS issue (Exhibit 1). Furthermore, that part of the credit curve remains generally attractive with the investment grade fair value curve still offering about 20 bp of inversion in 20-year notes compared to 30-year notes. AXS has demonstrated improving operating fundamentals and offers investors a stable split ‘A’/’BBB’ credit profile within the P&C and reinsurance segment.

Exhibit 1. P&C/Reinsurance – BBB+ or higher ratings, long-end of the curve

Source: Santander US Capital Markets, Bloomberg/TRACE BVAL G-spread indications

AXS 5.15% 4/01/45 @ +200/20YR; G+203; 7.02%; $79.48
Issuer: AXIS Specialty Finance PLC
unconditionally guaranteed by AXIS Capital Holdings Ltd.
CUSIP: 05464HAB6
Amount Outstanding: $250 million (non-index)
Rating: Baa1/A-
Global Issue
Closest Operating Comps: AGCL, PRE, RE, RNR, XL, Y

BID INDICATIONS FOR COMP SECURITIES / SWAP OPPORTUNITIES:

Source: Santander US Capital Markets

AXS is a Bermuda-based hybrid P&C/Reinsurance operator, some of whose closest operating comps include Alleghany (Y: A1/AA), Arch Capital (ACGL: Baa1/A-/A-), and PartnerRe (PRE: A3/A-/A-). The company recently exited the property catastrophe reinsurance business, opting instead to focus on specialty and casualty reinsurance lines. This has greatly reduced AXS’ exposure to periodic catastrophe losses, which have traditionally been a source of earnings volatility particularly over recent years. The current mix of business of the company’s annual $8.1 billion in gross premiums written is 72% insurance and 28% reinsurance. AXS has $29.3 billion in total assets with $16.2 billion in total cash and investments as of 2Q23.

AXS’ underwriting performance improved notably in the first half of 2023 from both the prior year period and earlier years that saw significant impacts from COVID-19, as well as exposure to higher cat losses. In the first half of 2023 the combined ratio (all-in costs relative to gross premiums written) has improved to 91.2% from 96.0% for the fiscal year 2022 and a recent peak of 109.6% at the heights of the global pandemic.

The company just reported third-quarter operating results on November 1. Both top and bottom-line performance came in well ahead of analysts’ expectations. Revenue was $1.43 billion versus a $1.25 billion consensus estimate, while operating EPS came in at $2.34 versus the $1.90 forecast. The combined ratio was 92.7%, which was up sequentially but down 11.6 points from the prior year. Catastrophe and weather-related losses contributed 2.9%, which was a 6 point improvement from third quarter 2022. On a year-to-date basis the combined ratio remains below 92%, which represents a stark improvement from the 101.7% prior five-year average. The only real criticism of AXS’ performance in the quarter seems to that the prior year reserve development ratio increased 0.2 points to -0.3% from -0.5% in the prior year period. A negative ratio indicates that reserves are redundant or in surplus relative to unpaid losses (the more negative the ratio the more excess reserves the company has). Despite the move year-to-date, AXS still remains on the right side of the spectrum.

AXS has a solid liquidity profile. The Company has just over $1.1 billion in cash on the balance sheet as of last quarter. Their first senior debt maturity is not until 2027, after recently paying down loans due of $250 million in 2021 and $500 million in the current year. AXS has not brought a public debt deal since 2019. The financial leverage ratio was 29.4% as of mid-year 2023.

AXS resolved Negative outlooks from the rating agencies back in 2022, having Stable outlooks assigned by both Moody’s and S&P. The previous Negative outlooks reflected temporarily deficient capital following the acquisition of Novae Group Ltd for $460 million, which closed in late 2017. AXS has since resolved that issue, regaining capital adequacy at the AAA level and insurance financial strength ratings of A2/A+ according to the agencies.

Dan Bruzzo, CFA
dan.bruzzo@santander.us
1 (646) 776-7749

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