The huge falls in bank shares this week were the more public sign of the pressure on financial institutions. But insurers and asset managers are equally concerned with the fate of billions of pounds, dollars and euros worth of certain UK bank bonds in which they are invested.
Concerns about the collapsing values of these lesser-known hybrid securities in turn hit the share prices of UK and European insurers Friday after analysts at Morgan Stanley said that US insurer Aflac’s capital could be hit by its $8bn (£5.8bn) holding of such bonds. Aflac on Friday reassured on its capital position.
The fact that the UK’s financial authorities were called to an urgent meeting with banks and investors this week to discuss the issues surrounding these tier one capital instruments – the next category of a company’s funding to default, after its equity – illustrates the seriousness of the issue.
Investors worry that the creeping involvement of the government in Britain’s banks and the losses the banks are set to suffer will lead to a suspension in coupons being paid on these bonds. Further, if British banks are nationalised, then these securities could be worthless.
“It is an absolutely key decision for the government to make,” said one insurance executive. “If you want to protect the economy you can’t afford to wipe out all this debt.”
“The banking sector and life assurance sector are very intertwined,” added Ned Cazalet, the independent life assurance analyst.
Swiss Re led the fallers, shedding almost 20 per cent, while in the UK, shares in Aviva fell almost 7 per cent and Prudential dropped 6 per cent.
Tier one capital is a form of hybrid capital instrument – not quite debt and not quite equity. Hybrids have been under pressure since Deutsche Bank in late December became the first big bank not to repay a more senior hybrid issue at the first opportunity, as is traditional.
The selling pressure began to increase late last week as bank stocks started to tumble, but it was not until Tuesday’s meeting between banks, investors, the Treasury, the Bank of England and the Financial Services Authority failed to produce any guidance that the rout really got under way.
Tier one bonds from Royal Bank of Scotland have been hardest hit, falling to less than 10 pence in the pound, but most other UK banks’ outstanding tier one notes now trade at well below half their face value. Most worrying for the market was the performance of the new Lloyds tier one, which began trading on Monday at face value of 100p and have already dropped to just 52p in the pound for the sterling issue with the shortest potential maturity.
“The bank capital debt market is frozen due to concerns over government involvement,” said Richard Thomson of Henderson Global Investors in London. “The lack of consistency in the treatment of bondholders in previous government actions has led to the inability of market participants to become comfortable with the risks involved.”
In the nationalisation of Northern Rock, some tier one securities were wiped out, while others continue to receive coupon payments. In the case of Bradford & Bingley, all tier one issues were worthless.
Analysts at SG CIB added that government support measures have also added to pressures in Europe and pointed to the example of BayernLB, which said last month that it would not make any payments on its tier one securities after the European Commission endorsed the bank’s recapitalisation plan.
UK life assurers report sales figures next week. Cazenove expects them to disclose “manageable exposures to bank hybrid debt”.
