Rate Hikes Expose Risks in $3 Trillion Life Insurance Sector

Welcome to . It’s Libby Cherry in London and Sonia Sirletti in Milan, where we're focused on the headaches that rising interest rates are giving insurance regulators. But before that, we have some key figures on the First Republic Bank crisis. We'll also tell you about the latest troubles a Blackstone-backed slaughterhouse cleaning company and Japanese hotel group Unizo. Follow this link to subscribe. Send us feedback and tips at [email protected] or Tweet/DM to @LibbyCherry98

By the Numbers

First Republic Bank’s tumultuous week has reignited concerns about the health of regional banks, Amelia Pollard writes. The California bank’s stock tanked anew this week after its quarterly earnings revealed a steep drop in deposits, and the lender said it was cutting staff and studying strategic options. Meanwhile, regulators are weighing in on whether to downgrade their private assessments of the firm. If they do, it would curb the bank’s access to Federal Reserve lending facilities.

Meanwhile, the largest US banks and the federal government appear stuck in a game of chicken as both sides seek to avoid steep losses. Major banks deposited $30 billion with First Republic last month to support the ailing institution, money they may not recover if the firm fails. 

Matt Levine's Money Stuff: First Republic Is in Limbo

Credit investors don’t seem to be seeing much of a silver lining to the situation, with the bank’s subordinated bonds due in 2046 cratering in recent days. As of Thursday, they were trading at 26.25 cents on the dollar, according to Trace data. 

Focus on Life Insurers 

Regulators and investors are stepping up scrutiny of the $3 trillion global life insurance industry after the recent bout of banking turmoil put a spotlight on any sectors deemed vulnerable to rising interest rates. 

In Europe, Italy’s  — owned by UK private equity firm  — has already gone bust, Germany’s top financial regulator, says it is closely monitoring liquidity of life insurance firms. In the US, shares of Lincoln National are down 60% since November after the company was hit with an unexpected charge. Ratings agencies have warned there are signs rising rates are prompting customers across the sector to look elsewhere, eating into new business and impacting profitability.

Read more: Private Equity’s Italian Bet Draws Heat After Solvency Turmoil

A major concern for the industry is the risk that clients decide to redeem their life insurance policies early to free up money for other higher-yielding investments as rates rise, known in the industry as lapse and surrender risk. In particular, BaFin is monitoring life insurers with a high proportion of single-premium business, where clients post a lump sum upfront to stash away, a spokesman for the regulator said by email.

“Lapse and surrender risk can be the insurance equivalent of a run on a bank if it happens on a mass scale and in a short time,” said Anthony Morris, head of quantitative strategies at Nomura. “The real potential problem here is that inflation does not go down as people expect it to, which will lead to still higher rates and tighten the screws on some insurance companies.”

The Eurovita blowup has sent tremors through an industry where bankruptcies are relatively rare. Just 219 failures or so-called near-misses were recorded across the entire European insurance sector, which currently has about 3,000 active insurance businesses, in the two decades before 2020, according to the European Insurance and Occupational Pensions Authority. 

Too-low liquidity buffers drove into special administration late last month, with growing worries over the life insurer’s future driving further waves of early redemptions. Fitch Ratings has said surrender rates in Italy have increased since the end of last year “highlighting a significant change in customer behavior” and flagged that “there could be isolated cases of weaker companies coming under pressure.”

Regulators are reviewing options to add to the €100 million already injected into Eurovita earlier this year to prevent thousands of clients’ savings being wiped out, according to people with knowledge of the matter who asked not to be named because details are private. Rival insurers and commercial partnershave been approached to take part in the rescue, the people said.

Most life insurers are better capitalized and have a more diversified range of products so it’s “quite difficult to imagine” contagion across the sector, said Taos Fudji, a credit analyst at S&P Global Ratings in Milan. 

French life insurers will likely have to raise their crediting rates this year to stop clients moving funds to investments including regulated savings accounts after the government raised the rate on the so-called Livret A accounts to 3%, analysts at S&P warned in a report published March 30. 

Lincoln National suffered a surprise $2.2 billion charge last year related to a life insurance product followed by a slew of analyst downgrades. At the end of 2022, Lincoln’s RBC was 377%, while the company has a target of 400%. That still puts it in line with the top 20 publicly traded US insurers, which maintain strong risk-based capital ratios typically running between 350% and 450%, according to Jeffrey Flynn, an analyst at Bloomberg Intelligence.

Lincoln has taken action to boost its capital ratio by cutting share buybacks and issuing preferred stock. Markets are still wary though. The cost of credit-default swaps that are used to hedge against losses on the insurer's debt has more than doubled in the past two months to 330 basis points. Lincoln declined to comment.

Any life insurance firms that have low liquidity buffers — usually smaller, unlisted companies — could potentially also be vulnerable to higher interest rates, according to Rotger Franz, a partner at Plenum Investments. He considers a Solvency II ratio of above 160% to be in the “comfort zone.” 

“The lesson we have to take as an investor is about solvency,” Franz said. “Below that you need to have a very detailed capital management strategy.”

High Alert 

• Short sellers have ramped up bets against commercial mortgage REITs, wagering that more borrowers will default on office debt as interest costs increase and property values fall. Short interest in the largest mortgage real estate investment trusts focused on business properties, including Blackstone Mortgage TrustStarwood Property Trust, hit post-pandemic highs in the past month, according to data compiled by S&P Global Market Intelligence. 
• FC Barcelona will pay €94 million a year in servicing the debt related to the revamp of its iconic Spotify Camp Nou stadium, club executives said on Thursday. The Catalan football club has raised €1.45 billion of debt to fund its Espai Barca project, which includes a redo of the football stadium but also a new Palau Blaugrana arena to play other sports like basketball and handball and other spaces like a hotel and a new museum and store. 

• China Evergrande Group was forced to extend by three weeks a deadline to get support from bondholders for its debt restructuring plan. Little more than 30% of Class C creditors, a group that includes margin loans and repo obligations, have signed up to a restructuring agreement by the deadline set on Thursday. The company needs 75% support for each of four classes of creditors.
• The corporate shell of an ex-industrial chemical maker filed for bankruptcy after a jury ordered it to pay more than $29 million to a woman who blamed tainted talc in cosmetic products for causing her cancer. Whittaker, Clark & Daniels, which is affiliated with Berkshire Hathaway, said in a petition filed in New Jersey that it owes creditors more than $1 billion, much of it to plaintiffs’ law firms that specialize in suing companies who used the talc. The bankruptcy petition allows it to halt lawsuits while it tries to work out a payment plan. 
• Listen to the latest episode of the Credit Edge Podcast for a discussion on the controversy surrounding so-called drop-down deals.

Notes From the Brink 

A child-labor scandal has plunged slaughterhouse cleaner Packers Sanitation Services into deep financial distress, Reshmi Basu and Erin Hudson report

The crisis began in February, when the US Labor Department accused the Blackstone-backed company of employing children as young as 13 in overnight cleaning shifts at meatpacking plants nationwide, exposing them to hazardous chemicals and dangerous equipment like back saws and head splitters. It fined the company $1.5 million.

In recent weeks, major clients have canceled contracts with the company, and investors are now concerned Tyson Foods could soon follow suit. Together the three account for about 40% of the company’s revenue, Bloomberg reported. 

The lost business and investor concerns around environmental, social, and governance risks has sent the value of the company’s $1.2 billion loan due in 2028 to around 52 cents on the dollar, from prices in the mid 90s, in a matter of days.

Read more: Blackstone Prodded by New York Child Labor Use at Meat Plants

Representatives from Blackstone, Packers Sanitation, Tyson didn’t respond to requests for comment. After the Labor Department’s announcement, Packers Sanitation said it has a zero-tolerance policy against employing people under age 18 and has taken steps to strengthen its controls. 

“We don’t want a single person under 18 working for PSSI, period — and take extensive steps to prevent individuals at the local level from circumventing our wide-ranging procedures,” the company said in a statement.

Blackstone has owned the company since 2018, and has taken about $430 million in dividends for itself by adding additional debt to the company’s balance sheet, according to Moody’s Investors Service. 

Troubles in Japan

became the first Japanese company to default on public bonds in six years after it filed for a court-supervised restructuring in Tokyo this week, Ayai Tomisawa and Catherine Bosley report

Once a hot M&A target, its bonds are now trading at just a fractionof their issue price after the pandemic caused a drop in overseas travel. 

The spotlight is now turned on the company’s lenders, which include several Japanese regional banks. Hokkoku Financial Holdings said it may not recover loans to the hotelier, and that it’s assessing the impact on its earnings. Shimizu Bank, San Ju San Financial Group and Bank of Kochi said they too may not get back money they lent.  

A meeting with banks is likely to take place after a public holiday in May, according to a lawyer representing Unizo.

More from The Terminal and Bloomberg Law 

• Berlin Fiber Operator Bonds Dive as Growth Costs Halve Profits
• Swedish Landlord Slumps After Asking Stockholders for Cash
• Weight Loss Brand Jenny CraigMulls Bankruptcy If Sale Fails 
• Cyxtera Taps Operational Adviser as Debt Negotiations Continue
• Tom Brady, Steph Curry, More Celebrities Want Discovery Halted
• Uses Cajoling $9 Billion Offer to Sell New Talc Bankruptcy
• Data Center Company Files for Bankruptcy for Second Time

Thank you for reading , Bloomberg’s twice-weekly newsletter on corporate crisis and distressed debt. Contact the author of today’s issue via email at [email protected] or Tweet/DM to @LibbyCherry98

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— With assistance by Michael Tobin, Ayai Tomisawa, Catherine Bosley, Reshmi Basu, Claire Boston, Amelia Pollard, Steven Arons and Erin Hudson