For a while now we have said that the very weakest link in Europe is not the banks, not the ECB, not triggered CDS, and not even the shadow banking system (well, infinitely rehypothecated Greek bonds within a daisychain of broker-dealers, which ultimately ends up at the ECB at a negligible repo discount, that could well be the weakest link - we will have more to say about this over the weekend) but two very specific insurers: Italy's mega insurer Assecurazioni Generali, which at last check had more Greek bonds as a % of TSF than anyone else, and Europe's biggest insurer and Pimco parent, Allianz, which is filled to the gills with pretty much everything (for more on Generali, or as we like to call it by its CDS ticker ASSGEN read here, here, here, and here). Well, Moody's just gave them, and the entire European space, the evil eye, and soon the layering of margin calls upon margin calls, especially if and when Greece defaults and a third of ASSGEN's balance sheet is found to be insolvent, will make anyone who still is long CDS those two names rich. Assuming of course the Fed steps in and bails out the counterparty the CDS was purchased from.
Here is the only chart one needs to know why ASSGEN will likely not be writing life insurance on itself (source):
ASSGEN's exposure to other PIIGS is far more hair-raising:
Generali’s main risk exposure to sovereign debt outside of Italy include Greece, Portugal, Ireland and Spain. The sovereign bonds are valued at market (accounted as Available For Sale). In aggregate, Generali has €12bn of gross exposure to troubled sovereign debt (excl Italy) and €2.1bn of net exposure (post tax and policyholder participation) accounting for c.14% of TNAV. We have assumed in our analysis that Generali would be able to share the impact of any potential impairments on its sovereign and financial (eg bank) exposures with policyholders given the decline in the minimum guarantees we have seen over the past few years (avg guarantee 2.3% in 2010). In practice the actual allocation will depend on the location of the bonds, the local country profit sharing rules and the level of buffer capital available in those entities (such as the free RfB buffer in Germany).
The Greek exposure is €3.0bn on a gross basis (per year end 2010) and €500m after policyholder participation and tax (based on amortized cost). This accounts for 20% and 3% of 2011e tangible book value on a gross and net basis respectively. We estimate Greek bonds will be valued at an estimated c50% of par based on a 6 year duration at end of 2011 Q2 with an estimated €160m unrealized loss included in shareholders’ equity after policyholder participation and tax. Should the debt rollover discussions be judged a credit event by either the rating agencies or auditors, we estimate that a €160m impairment would be realized through the P&L - assuming the haircut is in line with the market value of the bond. The overall impact on shareholders’ equity would be neutral (as it is already included).
Only if there is an additional haircut on the sovereign exposure that shareholders’ equity would be affected by additional impairments. In solvency terms, Generali includes unrealized gains and losses in its Solvency I and Solvency II calculations and the impairment of Greek debt should already be largely incorporated in our Q2 shareholders’ equity assumptions. Aggregating the main sovereign credit risk exposures outside Italy we estimate this factors in an unrealized loss of €3.2bn gross and €343m net unrealized losses in shareholders’ equity per end of 2011Q2 (see table below). The gap between the gross and net is material but is equivalent to 74bp of traditional life technical reserves. Substantially higher gross losses than those described below might belong more to shareholders than policyholders.
Overall, a write down in line with current marks on the Greek sovereign debt exposure will not have any incremental impact on the solvency ratio of the group as the debt is already included at market value. However, further swings in the value of sovereign debt, Spanish and Italian in particular will continue to affect TNAV and solvency until the situation stabilizes.
And here is ASSGEN's Tangible Common Equity ratio: 1.25x. Oops
Allianz is far more prepared for a collapse in the bond marke at 4.75
Moody's Investors Service has today announced the following actions on nine European insurance groups and related entities, to reflect (i) increased financial risks stemming from their operating and investment exposure to weakened European sovereigns and banks, as well as (ii) Moody's expectations of continued weak economic growth in certain of their key markets.
The following rating actions were announced:
Rating downgrades related to investment and operating exposures in Spain and Italy:
- Unipol Assicurazioni S.p.A.: Insurance Financial Strength Rating (IFSR) downgraded to A3 from A2 and remains on review for downgrade
- Mapfre Global Risks: IFSR downgraded to A2 from Aa3, negative outlook; Mapfre Asistencia : IFSR downgraded to A3 from A1, negative outlook)
- Caser S.A.: IFSR downgraded to Baa1 from A3 and placed on review for further downgrade
- Assicurazioni Generali S.p.A. and subsidiaries: IFSR downgraded to A1 from Aa3, negative outlook
- Allianz S.p.A.: IFSR downgraded to A1 from Aa3, negative outlook
Changes in rating outlook due to weakened economic conditions and outlook for key Euro-area markets:
- Allianz SE and subsidiaries: IFSR Aa3 affirmed, outlook changed to negative from stable
- AXA SA and subsidiaries : IFSR Aa3 affirmed, outlook changed to negative from stable; AXA Bank Europe : A2 senior debt affirmed, negative outlook
- Aviva Plc and subsidiaries: IFSR Aa3 affirmed, outlook changed to negative from stable
Initiation of reviews for possible downgrade of insurers affiliated with banks now subject to rating review:
- Scottish Widows Plc and Clerical Medical Plc: A1 IFSR and Baa1 hybrid securities on review for possible downgrade
- SNS Reaal N.V (Baa2 senior debts and see list below) and insurance operations (SRLEV / REAAL Schadeverzekeringen A3 IFSR): review for possible downgrade
And the two companies specifically:
ASSICURAZIONI GENERALI: IFSR of Assicurazioni Generali and subsidiaries (see list) downgraded by one notch to A1, negative outlook
The IFSR of Assicurazioni Generali (Generali) and subsidiaries (see list) has been downgraded by one notch to A1, negative outlook, following the downgrade of the Italian sovereign rating to A3, negative outlook. Moody's said that the downgrade of Generali reflects the insurer's direct exposure to Italian sovereign risk in terms of both investment portfolio and business profile. As at Q3 2011 Italian government bonds represented around 20% (EUR52 billion) of Generali's total fixed income portfolio, and 27% of its GWP were sourced in Italy in the first nine months of 2011.
Nonetheless, Moody's continues to rate Generali's IFSR two notches above the Italian sovereign rating, reflecting the insurer's broad diversification and flexible product characteristics which serve to insulate the company somewhat from stress related to the sovereign. Generali's non-Italian businesses accounted for over 70% of GWP in the first nine months of 2011 and Moody's believes that the risk sharing mechanism of the insurer's Italian life insurance products materially mitigates the exposure to Italian sovereign debt. This mechanism offers a relatively high ability to share losses with policyholders by reducing credited returns, given the current large spread between investments returns and average guarantees. For Generali's Italian operations this spread was, on average, 1.9% and 2.3% respectively on Italian traditional products with yearly and maturity guarantees.
Generali's negative outlook mirrors the negative outlook on Italy's government bond rating and reflects the uncertainties around the economic and financial environment in Italy. Given the negative outlook, Moody's said that the following factors could prompt a downgrade of Generali (i) a further downgrade of Italy's sovereign rating; (ii) a material deterioration of solvency and operating performance of the group; and/or (iii) a material deterioration of the financial flexibility of the group, for example if financial leverage exceeds 35% on a long-term basis.
- ALLIANZ SPA: IFSR downgraded to A1 from Aa3, negative outlook
The IFSR of Allianz S.p.A. (Allianz Italy), which is fully owned by Allianz SE, has been downgraded by one notch to A1, negative outlook following the downgrade of the Italian sovereign to A3, negative outlook. Moody's said that the downgrade of Allianz Italy reflects the insurer's direct exposure to Italian sovereign risk in terms of both investment portfolio and business profile. Italian government bonds represented around 60% of Allianz Italy's total fixed income portfolio, and 100% of its GWP were sourced in Italy in the first nine months of 2011. Nonetheless Moody's continues to rate Allianz Italy's IFSR two notches above the Italian sovereign rating reflecting the parental support of the group. Allianz Italy is the second-largest operation outside Germany for Allianz SE and consistently one of the largest contributors in terms of premiums and operating profit.
Allianz Italy's negative outlook mirrors both the negative outlook of Italy's A3 government bond rating and of the parent company, Allianz SE. Given the negative outlook on Allianz Italy, Moody's said that the following factors could prompt a downgrade of Allianz Italy; (i) a downgrade of Italy's sovereign rating; (ii) a downgrade of Allianz SE or a change in the status of the company within the German group; and/or (iii) a material deterioration in the stand-alone solvency, earnings, operating performance or capitalisation levels.
- ALLIANZ SE: Allianz SE and subsidiaries (IFSRs at Aa3 and see list) affirmed; outlook to negative from stable
The affirmation of Allianz's ratings (Aa3 IFSR and see ratings list) reflects the group's strong business profile, supported by an excellent geographic and business diversification, and strong financial profile, with good capitalisation, financial flexibility and excellent profitability. Moody's believes that the deterioration in sovereign credit quality has had a limited direct impact on Allianz' financial strength at this stage, given the Group's limited exposures to the most troubled countries in the Euro area.
Nonetheless, the change in outlook to negative from stable reflects the increased risk of deterioration in Allianz's asset quality, capital adequacy, profitability and financial flexibility given the weak economic environment evident in many of its operational markets.
Moody's notes that Allianz has a significant exposure to Italian government bonds (around 60% of shareholders' equity excluding minorities as of 30 September 2011). Moreover, the group maintains a high concentration risk to financial institutions more broadly (36% of the investment portfolio, excluding derivatives), especially to the German banking sector, although this includes a very high portion of covered bonds (23% of the investment portfolio). Moody's believes that the risk of deterioration in the quality of Allianz's investments has increased as evidenced by the negative outlook on Italian and other sovereign ratings, and the pressures on banks' credit quality resulting from deterioration in sovereigns' credit quality.
Furthermore, Allianz has material businesses within several weaker economies in the Eurozone, where the risk of deterioration in profitability is the highest. Notably, Allianz generates around 10% of its earnings and revenues from its Italian operations. Moody's added that any deterioration in profitability from these markets would add to the constraints on the group's revenues resulting from the expected low economic growth across Europe, and to the structural challenges Allianz faces in its domestic market, both in the very competitive P&C segment (Allianz reported a combined ratio of 104% in the first nine months of 2011 in Germany) and in the German life segment, with its inherent exposure to a prolonged low interest rate environment (Allianz' German life in-force guarantees were 3.3% on average at year-end 2010). Moody's notes that constrained profitability would also constrain the group's financial flexibility, through reduced fixed charge coverage.
Commenting on what could change the rating down, Moody's mentioned a significant deterioration of European sovereigns' credit quality, especially Italy, or some moderate deterioration coupled with a deterioration in group profitability. A permanent rise in financial leverage beyond the mid-thirties, or a deterioration in stand-alone credit fundamentals of main operating entities would also place pressures on Allianz SE's ratings.
Don't worry though, those who don't understand jack shit will tell you it is all contained. But please ask them why - and ask them why Lehman wasn't when everyone said it too was.