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Insurance Insights
PRIVATE CREDIT FOR INSURERS
With interest rates at ultra lows and likely to stay there for some time, insurance companies
face a daunting challenge in their efforts to secure high and stable income. That’s where
private credit comes in. Because these investments are less liquid relative to public credit
classes, they offer enhanced yield potential, diversification and attractive returns on capital.
BANK DISINTERMEDIATION MARCHES ON
The trend toward bank disintermediation has gathered pace across
global markets since the financial crisis, as alternative providers
of capital—insurance companies, asset managers, pension
funds and specialty finance firms—move to fill the void left by
regulation-restrained banks retreating from certain lending activities.
We expect this trend to persist, opening up attractive investment
opportunities for well-capitalized institutional investors in direct private
credit. It may even help bring greater stability to the global financial
system overall by adding new sources of liquidity to the market.
INSURERS’ ASSETS NEED TO WORK HARDER
Even in the Best Case Scenario, Yields on Maturing Bond Portfolios Are Trending Lower
4
Percent
3
2
1
0
Dec 10
Dec 11
l Gradual Rise (Market Expectations)*
Dec 12
Dec 13
Dec 14
l Rates Stay at Current Levels
Dec 15
l Faster-than-Expected Rise
Dec 16E
Dec 17E
Dec 18E
l Rates Decline Further
Historical information is provided for illustrative purposes only.
As of June 30, 2016
* Base case, as reflected in current market yield curve
Based on euro swap rates with seven-year maturities (plus a 1% spread), averaged over rolling 10-year periods. Display depicts the impact of various interest-rate
scenarios on a typical insurance fixed-income portfolio as maturing bonds are progressively replaced with fresh investments.
Source: Bloomberg and AB Research
For Recipient’s Use Only
Dec 19E
TAP THE PREMIUM IN PRIVATE CREDIT
++ Accounting Benefits. Private credit enjoys favorable accounting
treatment (booked at cost rather than mark-to-market).
We’ve identified three main pillars of private-credit investing: direct
lending to middle market corporations, direct US prime ­residential
mortgage lending and direct commercial real estate lending.
These share a number of characteristics that insurers should find
­particularly appealing:
DIRECT LENDING TO MIDDLE MARKET COMPANIES
Middle market businesses account for roughly one-third of
­private-sector GDP in the US, yet they have far less access to
financing than their larger counterparts. Stiffer banking regulations
and capital requirements have magnified this supply/demand gap.
++ Enhanced Return Profile. Given the lack of a deep secondary
market for private credit, investors receive a yield premium over
comparable public credit investments.
Insurers have an opportunity to tap the higher return potential
available in this large, highly fragmented and scalable corner of
corporate financing, which generates robust transaction volumes
that are not highly correlated to the capital markets generally. This
market also offers the chance for attractive returns on RBC, which
are higher than returns on high-yield bonds, as their yield premiums
more than compensate for their capital charges.
++ Rising-Rate Defenses. Middle market loans and commercial
real estate, by virtue of their floating-rate characteristics, provide
excellent protection against rising rates. Residential mortgages
are fixed rate but offer a yield premium to cushion the impact of a
rate rise.
++ Stable Cash Flows. These investments provide good
cash-flow matching versus liabilities given their stable payment
characteristics.
This investment also benefits from downside protection in the form
of strong collateral packages and covenants, accomplished through
private negotiation of legal documents. This allows AB’s private credit
investing team to influence holding company actions in the event of
an adverse credit event, and is differentiated from broadly syndicated
loans and high-yield bonds, where investors are often not afforded
this protection.
++ Capital-Charge Friendly. These investments provide capital
efficiency across different jurisdictions. In terms of Solvency
II, they allow for the matching adjustment, which may provide
additional capital relief. For risk-based capital (RBC), all loans are
rated by a NRSRO1 for efficient treatment.
ILLIQUID ASSETS OFFER DIVERSIFICATION AND ENHANCED YIELD
High
Middle Market Loans
Yield
Risk-Sharing Transactions
Transitional CRE Loans
Private Placements
Residential Mortgages
High Yield
Leveraged Loans
RMBS
CMBS
IG Corporate Credit
EM IG
Cash
Low
Low
High
Risk
l Traditional
l Private Credit
For illustrative purposes only.
CRE: commercial real estate; RMBS: residential mortgage-backed securities; CMBS: commercial mortgage-backed securities
Source: AB
1Nationally recognized statistical rating organization
For Recipient’s Use Only
OUR STRATEGY
++ Target primary-issue middle market credit opportunities, directly
sourced and privately negotiated
++ Focus on first lien, unitranche and second lien loans, while
considering other debt structures, equity and co-investment
opportunities
++ Our middle market debt portfolio management team had roughly
$2.6 billion2 in assets under management as of June 30, 2016
DIRECT US PRIME RESIDENTIAL MORTGAGE LENDING
The US residential mortgage market is on a strong fundamental
footing, buttressed by an improving economy, a much diminished
supply of homes for sale and healthier borrower credit trends. At
the same time, mortgage-credit availability has tightened, led by
­government-sponsored enterprises (GSEs) Fannie Mae and Freddie
Mac, which continue to curb their involvement.
Prime jumbo residential mortgages offer a yield premium to those of
investment-grade corporate credit and agency mortgage-backed
securities. Because they receive favorable NAIC3 RBC treatment,
these loans are also attractive on a return on i­nvested capital basis.
(Prime jumbo residential mortgages are filed and classified on
Schedule B.) They are also fully documented and adhere to strict
underwriting standards, including loan-to-values of less than 80%.
Finally, because mortgage lending is at a much earlier stage in
the credit cycle than the corporate credit market generally, these
investments can help diversify credit portfolios.
OUR STRATEGY
++ Invest in newly originated, fixed-rate prime jumbo residential
mortgages with attractive risk-adjusted return potential
++ Leverage AB’s strategic relationship with Bank of America’s
network of originators, begun in 2015, which we believe gives
us a competitive advantage in sourcing, analyzing, acquiring and
managing residential mortgages
++ Our securitized mortgage portfolio-management team had more
than $20 billion in assets under management as of June 30, 2016
DIRECT COMMERCIAL REAL ESTATE LENDING
While banks, insurance companies and commercial m
­ ortgagebacked securities lenders have reentered the US commercial
real estate market, their activities have been largely confined
to the ­highest-quality, stable assets in specific property types
and geographies. The overall lending volume remains well below
recent peaks.
As important, a historically high volume of loans—roughly $1 trillion
worth—is set to mature over the next couple of years, much of which
is underlevered. We believe this runoff will generate ample credit
demand in the underserved “transitional” loan space to borrowers
in need of flexible debt capital. The resulting imbalance between
higher loan demand and low supply has created what we view as
a compelling opportunity for alternative credit providers who can
step in and provide much-needed financing. These investments also
offer the potential for high returns on RBC, as their required capital
charges are modest.
OUR STRATEGY
++ Originate—and at times buy—first-mortgage loans on transitional
commercial real estate
++ Structure loans with significant reserves, attractive prepayment
terms and interest-rate protection
++ Seek to build a diversified portfolio that manages concentration
and idiosyncratic risks across geography and property type,
among other factors
++ Our commercial real estate debt team had roughly $2.3 billion in
assets under management as of June 30, 2016
WHY AB?
Building on more than three decades of experience, AB has significantly expanded its private-credit capabilities
over the past few years. We’ve done this by acquiring teams with impressive credentials, strong track records
and disciplined credit cultures that match our own, as well as through internal product development. Today,
we are pleased to offer our clients a team dedicated to each of the investment opportunities highlighted here.
2Figure accounts for total investable assets, such as equity and debt
3National Association of Insurance Commissioners
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LEARN MORE
[email protected] | ABGLOBAL.COM
NOTE TO ALL READERS:
The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P.
makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past
performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational
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Neither AllianceBernstein Institutional Investments nor AllianceBernstein L.P. provides investment advice or deals in securities in Canada. Note to European Readers: This
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it intended to be an offer or solicitation, and does not pertain to the specific investment objectives, financial situation or particular needs of any person to whom it is sent. This
document is not an advertisement. AB is not licensed to, and does not purport to, conduct any business or offer any services in any of the above countries. Note to Readers in
Malaysia: Nothing in this document should be construed as an invitation or offer to subscribe to or purchase any securities, nor is it an offering of fund-management services,
advice, analysis or a report concerning securities. AB is not licensed to, and does not purport to, conduct any business or offer any services in Malaysia. Without prejudice to the
generality of the foregoing, AB does not hold a capital-markets services license under the Capital Markets & Services Act 2007 of Malaysia, and does not, nor does it purport to,
deal in securities, trade in futures contracts, manage funds, offer corporate finance or investment advice, or provide financial-planning services in Malaysia. Note to Singapore
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S.à r.l. is the management company of the portfolio and has appointed ABSL as its agent for service of process and as its Singapore representative. This document has not been
reviewed by the MAS.
MARKET RISK:
The market values of the portfolio’s holdings rise and fall from day to day, so investments may lose value. Interest-Rate Risk: Fixed-income securities may lose value if interest
rates rise or fall—long-term securities tend to rise and fall more than short-term securities. The values of mortgage-related and asset-backed securities are particularly sensitive to
changes in interest rates due to prepayment risk. Credit Risk: A bond’s credit rating reflects the issuer’s ability to make timely payments of interest or principal—the lower the rating,
the higher the risk of default. If the issuer’s financial strength deteriorates, the issuer’s rating may be lowered and the bond’s value may decline. Inflation Risk: Prices for goods
and services tend to rise over time, which may erode the purchasing power of investments. Foreign (Non-US) Risk: Investing in non-US securities may be more volatile because
of political, regulatory, market and economic uncertainties associated with such securities. These risks are magnified in securities of emerging or developing markets. Currency
Risk: If a non-US security’s trading currency weakens versus the US dollar, its value may be negatively affected when translated back into US dollar terms. Diversification Risk:
Portfolios that hold a smaller number of securities may be more volatile than more diversified portfolios, since gains or losses from each security will have a greater impact on the
portfolio’s overall value. Derivatives Risk: Investing in derivative instruments such as options, futures, forwards or swaps can be riskier than traditional investments, and may be
more volatile, especially in a down market. Leverage Risk: Trying to enhance investment returns by borrowing money or using other leverage tools may magnify both gains and
losses, resulting in greater volatility. Below-Investment-Grade Risk: Investments in fixed-income securities with lower ratings (commonly known as “junk bonds”) tend to have
a higher probability that an issuer will default or fail to meet its payment obligations. Liquidity Risk: The difficulty of purchasing or selling a security at an advantageous time or price.
The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P.
makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized.
AllianceBernstein Investments, Inc. (ABI) is the distributor of the AllianceBernstein family of mutual funds. ABI is a member of FINRA and is an affiliate of AllianceBernstein L.P., the
manager of the funds.
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