The Long and Short

New round of P-CAPs

Dan Bruzzo, CFA | May 16, 2025

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.

Another round of pre-capitalized securities (P-CAPs) have come out in the insurance sector. This is the second time this year that a pair of these structures launched in the same week. The market continues to mature with increased awareness and acceptance by institutional investors. Available liquidity discounts appear to be closely commensurate with the credit risk of the issuer and are increasingly consistent by final maturity. The opportunity for spread tightening is more limited, but there is reason to remain constructive with more potential issuance and the prospect of seeing the structure grow beyond the insurance industry.

Lincoln National (LNC: Baa2/BBB+/BBB+) launched a new 30-year P-CAP named Belrose Funding Trust II, the second time the issuer has used this structure. LNC priced $1 billion at a spread of 185 bp over the 30-year compared to initial price talk of 205 bp. The deal has tightened by about 7 bp to 8 bp after debuting and now trades at about 35 bp to 40 bp wider than the closest maturity unsecured bond, the LNC 4.375% ‘50s (Exhibit 1). But the long-dated comparable bonds are being tendered. The real discount is likely closer to the high 20s, which is larger than the 17 bp to 18 bp spread picks available in the long-end of the curve for peers such as MET, PFG and LIBMUT. It may compress a little over time, but it does appear there will be a commensurate risk premium associated with the underlying issuer versus peers, as is also the case with EQH.

The decision by LNC to revisit the P-CAP structure with a longer-dated maturity, in conjunction with a tender offer, seems to make strategic sense. Since the company took a sizable actuarial assumption charge back in third quarter of 2022, LNC has been downgraded by Moody’s and S&P. Both agencies have raised concerns about LNC rebuilding adequate capital cushion against periods of heightened market volatility. The P-CAP enables the company to keep liquidity in reserve that can be accessed in an emergency, without initially raising overall leverage ratios.

Also returning to the P-CAP market this week was Voya Financial (VOYA: Baa2/BBB+) with a 10-year issue named Peachtree Corners Funding Trust II. The company’s previous P-CAP matured earlier this year. The bonds priced at a spread of 150 bp over the 10-year note compared to initial price talk of 185 bp. The new issue tightened about 5 bp or 6 bp and now appears to trade at spread in the high teens to the existing 2034 maturity senior unsecured VOYA bonds outstanding. This is a relatively modest liquidity discount in a ‘BBB’ name and appears unlikely tighten by much relative to the unsecured securities, but still offers decent carry for a stable underlying issuer.

The applications of the P-CAP structure appear to have broader potential outside of the insurance industry. In 2023, power generation company Vistra Corp (VST: Baa3/BBB- secured rating) issued a P-CAP structure, entitled Palomino Funding Trust I. With time, it seems possible that other utility credits might see the benefits of holding additional liquidity in reserve off balance sheet. P-CAPs are a unique trust structure mostly used by insurers to raise funds while keeping leverage off the balance sheet until the funds are eventually needed. The market appears to increasingly acknowledge that P-CAPs 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. This fact was given its first real world case study back in October of last year by Unum (see below).

Some other examples of recent P-CAPs in the insurance industry (exhibit 1):

MetLife’s (MET: A3/A-/A-), 200 Park Funding Trust
Principal Financial’s (PFG: Baa1/A-/A-), High Street Funding Trust
Liberty Mutual’s (LIBMUT: Baa2/BBB), Beacon Funding Trust
Equitable Holdings’ (EQH: Baa1/A-), Pine Street Trust
Prudential Financial’s (PRU: A3/A/A-), Five Corners Funding Trust,

Exhibit 1. Selected insurance P-CAPs and their senior unsecured credit curves

Source: Santander US Capital Markets LLC, Bloomberg/TRACE – G-spread indications only

Exhibit 2. Spread in insurance P-CAPs and comparable senior unsecured debt

Source: Santander US Capital Markets LLC, Bloomberg/TRACE

Primer: Pre-capitalized securities (P-CAPs)

Pre-capitalized securities or P-CAPs are a unique trust structure that have been mostly 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 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/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 effectively 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 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 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 less attractive to issue new debt. Debt issuance to the trust can also occur as a result of a mandatory exercise event, which is described below. So far, no insurance 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 insurance company.

In 2024, Unum Group (UNM: Baa2/BBB/BBB) dissolved their outstanding Hill City Funding Trust (UNM 4.046% ‘41%). Since the P-CAP structure was conceived, no other issuer had actually executed an exercise event before, which helped demonstrate the fallback nature of these liquidity reserves. As the first dissolution, the UNM bonds served as a case study for execution, and proof of concept, particularly for investors that might still be reluctant about the structure itself. UNM took ownership of the Treasury securities previously held in the trust by issuing senior unsecured debt with identical coupon, principal and maturity into the trust. Therefore, the holders of the notes will continue receive the same coupon payments unabated, while the ratings and seniority of the bonds will remain the same.

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

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