The Long and Short
New pre-capitalized securities (P-CAPs) in the market
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.
Equitable Holdings (EQH: Baa1/A-) recently announced a partial tender for one of the company’s existing pre-capitalized securities, or P-CAPs. P-CAPs are a unique structure that gives a company access to debt funding that sits off the balance sheet in a trust until the company needs it. The bonds trade in the secondary market at a discount to comparable senior unsecured debt from the same company. To help fund the tender, Equitable issued a new P-CAP. This is the first P-CAP issued in the primary market in roughly a year and is the first instance of a company actively tendering for P-CAP debt by issuing another one. The action by Equitable should remind investors that they continue to be well compensated for the moderate give-up in liquidity and for the structural implications associated with these securities.
P-CAPs are most common in in the insurance industry. Examples include Equitable Holdings’ Pine Street Trust, Prudential Financial’s (PRU: A3/A/A-) Five Corners Funding Trust, Voya Financial’s (VOYA: Baa2/BBB+) Peachtree Funding Trust, the 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-). Those P-CAP structures offer spread to comparable securities in the range of 15 bp to 70 bp, depending on issuer or part of the maturity curve (Exhibit 1). This continues to represent generous compensation given that they are rated in-line with their respective senior unsecured notes. The rating agencies consider the trust structures pari passu with comparable senior debt, since the issuers are required to issue senior debt into the trust if they ever take ownership of the Treasury securities that are held on issuance.
Exhibit 1: Insurance P-CAPs versus senior unsecured credit
Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications
Exhibit 2: P-CAPs offer spread to comparable senior unsecured securities
Source: Santander US Capital Markets LLC, Bloomberg/TRACE G-spread indications
EQH recently issued $600 million in 30-year P-CAPs at a launch level of 175 bp over the Treasury curve, which subsequently tightened by about 7 bp or 8 bp. That compares with a rough level of approximately 115 bp to the curve for EQH’s senior unsecured long-dated securities (EQH 2048s). A day earlier, the company had announced a 2-part $500 million cash tender offer, which included up to $275 million of the EQH 4.572% ’29 P-CAPs, of which there are $600 million outstanding issued in 2019.
While tender issue actions are common among corporate bond issuers, this is the first instance of an insurance company executing this type of action on a P-CAP. It is relevant because it demonstrates another means by which an issuer can dissolve the trust structure of the securities, without ever taking ownership of the debt or having to wait until original maturity of the securities. Effectively, EQH has moved their capital structure further out the maturity curve, again without ever actually having to add new leverage on their balance sheet. The flexibility to do so is a prime motivator in why issuers choose to implement this structure. With some of the outstanding P-CAPs getting long in the tooth, it is possible we could see other issuers follow suit.
Primer: Pre-capitalized securities (P-CAPs)
Pre-capitalized securities or P-CAPs are a unique trust structure that have been mostly used by insurance companies seeking to issue debt, but also wanting to keep leverage off the balance sheet until the funds are eventually needed. The bonds trade in the secondary market at a discount to comparable senior unsecured debt issued by the same insurance companies.
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 by the underlying 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 million 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 debt of the issuer, as the rating agencies view the credit quality as being closely linked to that of underlying insurance company. The notes issued into the trust on exercise would be pari passu with all senior debt obligations of the underlying 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 company that has issued P-CAPs has ever exercised either voluntarily or through automatic/mandatory action.
An automatic exercise event occurs if either a bankruptcy event occurs at the underlying 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 issuer.
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