Regulatory threat drives insurers into sub bond market

* Grandfathering provision increases September bond sales

* Insurance capital to borrow riskier elements from bank CoCos

* Market sell-off presents obstacles for latecomers

By Aimee Donnellan

LONDON, Sept 26 (IFR) - Europe's insurers are charging into the subordinated bond markets, keen to boost capital at rock-bottom yields before regulators force them to sell more aggressive structures.

This month seven insurers have raised over 3.5bn equivalent of subordinated debt in euro and dollars, a sharp increase from last September, when just one insurer came to market.

"It makes sense for insurers to consider issuing perpetual bonds where they could count towards their Tier 1 capital base once Solvency II is implemented," said Jake Atcheson, head of insurance debt capital markets at Citigroup.

Unlike banks, which have needed to turn to subordinated debt in recent years to raise more regulatory capital, insurance companies have escaped relatively unscathed.

But that is changing. Insurers will soon have to sell instruments with features that allow regulators to wipe out capital quickly and restore the health of the institution.

"Under Solvency II, insurance Tier 1 bonds will look similar to bank Additional Tier 1 capital," said Atcheson.

"They will have loss-absorption features including share conversion or write-down (temporary or permanent), non-cumulative coupon deferral and no dividend pushers or stoppers."

So insurers have incentive to rush to market, as they can save around 2% per year on a perpetual bond that avoids more aggressive features, bankers say.

Continental European issuers are now readying deals in the hopes they will be grandfathered in by regulators.

Macif and Credit Agricole Assurances are seeking to raise this kind of debt, while Italian borrowers like Generali are also expected to join the fray.

"Insurance companies are in a transitional period where it's still possible to issue old-style instruments that do not incorporate some of the riskier elements of Solvency II's definition of own funds," said Franck Viort, head of insurance DCM at BNP Paribas.

"We don't know precisely when the cut-off date will occur, but it could be as early as the end of this year."

This uncertainty is persuading issuers to sell perpetual Tier 2 bonds without loss absorption or conversion language, which they hope their national regulators will count as Tier 1.

Even so, some national regulators like the PRA want insurers to comply fully with Solvency II from the get-go.

"It's interesting to see that different jurisdictions are taking different views on this," said Atcheson.

"For example, we haven't seen any perpetual issuance out of the UK this year, which is probably because the PRA has said it wants insurance debt to be 'in the direction of travel of Solvency II.'"

TOO MUCH, TOO SOON

Investors are of course happy to buy bonds without aggressive features, and the deluge of insurance bonds in recent weeks has attracted reasonable order books.

"The less loss-absorption language the better, when it comes to subordinated bonds," said Robert Montague, a senior investment analyst at ECM Asset Management.

"Investors would prefer to buy bonds without this additional language. And when it comes to structures, we prefer dated over perpetual debt."

The rush has created something of a logjam of supply, though a recent sell-off in the subordinated market may limit the issuance window.

Since July, insurance sub bonds have been bouncing around in the secondary, with some widening around 90bp.

"We've seen a lot of supply in recent weeks and the perpetual notes have been too tight, which has led to underperformance," said Montague.

"Some of these bonds that have been issued in recent weeks are now three to four points down in the secondary market."

While investors seem happy with the trades on offer for now, some are questioning whether there will be sufficient demand for riskier structures down the road.

"Investor appetite for new-style insurance Tier 1 bonds is uncertain at the moment, given that we don't know how these instruments will be structured," said Thomas Maxwell, investment director at Standard Life Investments.

Viort at BNP Paribas agreed, saying that insurers are unlikely to issue more than one deal a year as it does not make sense to load up on costly capital. (Reporting by Aimee Donnellan; Editing by Alex Chambers and Marc Carnegie)