Swiss Re Pays Price for Uncertainty

By | February 4, 2009

Investors have punished Swiss Re this year on fears it could write down further billions of dollars of toxic assets. A lack of transparency from the world’s second-largest reinsurer is adding to worries.

“We think the downwards trend is set and will continue, as the major risks are still in place and so far no deleveraging is visible,” said Kepler Capital Markets analyst Fabrizio Croce.

Croce said he was most concerned about Swiss Re’s predominantly ‘BBB’ credit rating and lower corporate bond portfolio, exposure to structured products and credit default swaps.

Swiss Re shares have fallen 42 percent in 2009, against a fall of 14 percent in the DJ Stoxx European insurance sector index, with uncertainty persisting over its full-year results due on Feb. 19, which some analysts fear could herald ratings downgrades and capitalization problems.

“We believe recent share price volatility reflects uncertainty surrounding the full year numbers and in particular the level of writedowns which Swiss Re might see on its investment portfolio,” analysts at Credit Suisse said in a note.

“We see significant risk that Swiss Re will opt for a form of capital strengthening if it has to take substantial marks,” they said, adding Swiss Re would take any action to avoid losing its ‘AA’ rating as this would hurt business.

The Credit Suisse analysts believe Swiss Re could sell some of its toxic assets to the Swiss National Bank (SNB), removing some exposure from the balance sheet, and issue CHF 2 billion ($1.723 billion) of mandatory convertible notes.

The model would be similar to the bailout of Switzerland’s largest bank, UBS, which in October 2008 received a CHF 6 billion ($5.166 billion) cash injection from the state and agreed to park around CHF 60 billion ($51.656 billion) of toxic assets in a special purpose vehicle.

Swiss Re and the SNB would not comment on the possibility of a capital increase and state bailout.

The level of capital at the end of 2008 should be enough for Swiss Re to keep its ‘AA’ rating, analysts said, but worries remain that there is no substantial buffer for further writedowns because it still has considerable risk exposure.

Shareholders’ equity was CHF 24 billion ($20.66 billion) at the end of the third quarter of 2008, but Swiss Re could lose its ‘AA’ rating if this figure dips below CHF 20 billion ($17.217 billion), said Sal. Oppenheim analyst Rene Locher.

Since November 2007 the company has written down nearly CHF 3 billion ($2.582 billion) on structured credit default swaps.

At the end of the third quarter the company had CHF 31 billion ($26.678 billion) in corporate bonds, 50 percent rated ‘BBB’ or lower, and CHF 40 billion ($34.433 billion) in structured products.

But Swiss Re could still earn its way out of trouble if it manages to keep its balance sheet risks in check, as personal and commercial insurance prices are likely to increase alongside rising demand for reinsurance.

While smaller German competitor Hannover Re also remains stretched on capital, it is forecasting a return on equity of up to 20 percent for 2009.

The world’s biggest reinsurance player, Munich Re, has kept a strong balance sheet throughout the crisis because it avoided many of the risks taken by its rivals, making it a firm favorite with analysts.

“There are only two insurers left that still have a significant capital buffer,” said Credit Suisse analyst Peter von Moos, referring to Munich Re and Baloise. “A lot of names will have to walk a thin line between the need to preserve capital and demonstrate capital strength.”

Many market players have wondered which insurers could be the next victims of the global financial crisis since AIG, once the world’s biggest insurer, was saved from failure by a U.S. government bailout running to over $150 billion after the company took massive hits on investments.

Soon after, Dutch companies ING and Aegon both received capital injections from the Dutch government and ING was forced to turn to the government again for help in January.

Insurance shares have tumbled on worries that corporate bond defaults could hit their investment portfolios.

The capital of companies like Swiss Life with considerable corporate bond investments is vulnerable to any large wave of defaults this year and a number of insurers – Swiss Life, Aviva , Axa and Generali (GASI.MI) – look tight on solvency.

Insurers were hit hard in the last bear market in 2002/03, and lowered their exposure to equities in favour of more conservative investments like treasuries, though not quickly enough to escape the current stock market slump unscathed.

But in contrast to banks, which rely on deposits and funding from capital markets, insurers have relatively stable funding from premiums.

“Winners will be companies with strong balance sheets and strong equity positions. They are in the position to gain market share as companies with weak balance sheets have to downscale top-line growth,” said Locher.

(Editing by David Cowell)

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