Swiss Re’s hybrid attraction

Strong 2012 results and an improving business profile make Swiss Re’s $A hybrids attractive.

Summary: Global reinsurer Swiss Re has reported a $US4.2 billion net profit for 2012, and its business profile is strengthening. The group’s Australian dollar hybrid issue presents a low investment risk for investors.
Key take-out: The built-in “step-up” penalty in Swiss Re’s $A hybrid, and the group’s strong position, make it likely the group will call in May 2017.
Key beneficiaries: General investors. Category: Income.

The latest financial results of diversified global reinsurer Swiss Re, and an ever improving business profile, mean that its Australian dollar hybrid represents excellent relative value.

Sustained improvement in profitability and equity since the GFC have underpinned the improvement in credit fundamentals for the world’s second-largest reinsurer behind Munich Re, which has reported a net profit after tax of $US4.2 billion and total equity of $US34 billion for the 2012 financial year.

However, the recent results did come with one negative for debt holders being the return of excess capital by way of increased ordinary dividends and a special dividend which will see $US2.8 billion returned to shareholders.

Swiss Re maintains a very strong balance sheet with a high quality investment book. Recent reductions in overweight sovereign debt positions, particularly US Treasuries, into corporate bonds have been perfectly timed to maximise the performance of the investment book.

Swiss Re has both a fixed and a floating-rate Australian dollar hybrid, both with a first call of 25 May 2017 (see Table 2). These hybrids were first issued in 2007 with the old style “step-up” penalty should they not call at the first opportunity. This feature coupled with the very strong financial standing of the group gives me confidence that the company will call in May 2017. The new style listed major bank equity hybrids do not have this feature.

Table 2 shows that the estimated yield to maturity for both hybrids is almost the same. However the way the payments are made is different. The fixed-rate bond pays a high fixed interest payment until maturity and given the $103.50 purchase price, the running yield (your effective interest payments made for a year) is 7.38%, providing a high income. Whereas the floating-rate hybrid is trading at a discounted purchase price of $92 and the running yield is lower at 4.84%. However, you make a capital gain when the hybrid is repaid as you receive $100 at maturity. The fixed-rate bond will show a loss at maturity of $3.50, but this is compensated by the high fixed interest payments in the meantime.

Swiss Re fixed and floating are two of the best relative value hybrids available and would make a great addition to a portfolio as they provide:

  • Excellent diversification with a large, well-regarded international company away from Australian domestic names.
  • An opportunity to fix returns, providing certainty of income. Very few ASX listed hybrids offer this feature. All the major bank hybrids are floating rate.
  • Very low risk with the hybrids being rated two to three notches higher than our major bank listed hybrids.

Elizabeth Moran is director of education and fixed income research at FIIG Securities.

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