This week we identify and compare two very similar debt instruments, both denominated in Swiss francs, from two of Europe's most reputable insurance companies, Swiss Life (OTC:SZLMF) and SRLEV N.V., a (OTC:SNREF) subsidiary. Both of these high yielding investment grade bonds have a first call date in 2016, at which time they will either be called by the company, or will reset their coupon rate to the five year CHF swap rate (the Swiss National Bank's key lending rate) plus the initial spread (which was 3.55% for Swiss Life, and 5.625% for SRLEV N.V.) We have targeted acquiring these bonds at close to par value, which would give holders a yield close to their current coupon rate of 5.25% for Swiss Life, or 7% for SRLEV N.V. These are two of the best rates that we have found for investment grade debt denominated in Swiss francs, and believe this to be a great opportunity for adding this traditionally strong currency into our Foreign and World Fixed Income holdings.
Wealth Preservation Concerns
As an array of mixed signals across the economic landscape continue to cajole global equity markets higher, wealth preservation and risk aversion remain top priorities for many people. Declining equity and property prices, ultra-low interest rates, minimal pay raises, elevated inflation, ineffective politicians, potentially increased taxes, and the Fed's constant printing of more money in what may be an effort to not only backstop the U.S. economy but also that of Europe, have all precipitated into a widespread erosion of wealth that will likely continue until the aforementioned conditions begin to change.
As governments around the world lower their exchange rates in efforts to bolster competitiveness, it will cause a chain reaction in which countries involved in trade will need to weaken their own currency to bring it into a ratio of exchange that is acceptable to their perceived valuation. With the U.S. money supply up over 60% in less than 4 years (over 12% per year), many governments (including the Congressional Budget Office of the United States) believe that the dollar will weaken over the longer term. Just last week, U.S. central bank official James Bullard, while speaking behind closed doors in Beijing, warned that nations that tie their currency to the dollar are at risk of importing inflation in the current environment.
We have undertaken the effort to protect our client's assets against the persistent destruction associated with an ever increasing supply of federal dollars, by scouring the globe in search of sound investments in the strongest global economies, and it is why we have chosen these high yield, 5 year re-adjusting (floating) rate, perpetual Swiss franc bonds as This Week's Best Bond.
Switzerland is a peaceful, prosperous, and modern market economy with low unemployment, a highly skilled labor force, and a per capita GDP among the highest in the world. Switzerland's economy benefits from a highly developed service sector, led by financial services, and a manufacturing industry that specializes in high-technology, knowledge-based production. Its economic and political stability, transparent legal system, exceptional infrastructure, efficient capital markets, and low corporate tax rates also make Switzerland one of the world's most competitive economies. The Swiss have brought their economic practices largely into conformity with the EU's, to enhance their international competitiveness, but some trade protectionism remains, particularly for its small agricultural sector. The fate of the Swiss economy is tightly linked to that of its neighbors in the euro zone, which purchases half of all Swiss exports.
The demand last year for the Swiss franc by investors seeking a safe haven currency resulted in the independent Swiss National Bank (SNB) conducting major market interventions to prevent further appreciation of the Swiss franc, as the franc's strength made Swiss exports less competitive and weakened the country's growth outlook. In the final quarter of 2011 exports fell 6.8% due to its strong currency. While unemployment is low at 3.1%, GDP fell to 1.4% in 2011, and the debt to GDP remains lower than most nations at 55%. The inflation rate for Switzerland was reported at -1 percent in March of 2012, with expectations for more to the downside. However, judging from the SNB's own quarterly report (released today) on the inflation forecast, it appeared to be heading towards a bottom, then a gentle upwards slope.
As deflation concerns begin to wane, there will be increasing pressure for an exit strategy from the EUR/CHF "floor," along with other unconventional policy strategies. Furthermore, there is increasing evidence of international and internal pressure to limit continued intervention. The SNB took a huge risk, which has paid off so far, in their strategy but the SNB's balance sheet is slowly expanding, increasing the risk that the 1.2000 floor might come with a heavy price. From a historical perspective, the last time the SNB pegged the franc to another currency (the Deutsche mark) it lasted for about years before it was unwound.
Public debt to GDP
|102.8%||US$ 1.29 Trillion||1.474 Trillion||2.239 Trillion|
Swiss franc (CHF) per U.S. dollar -
About Swiss Life
The Swiss Life Group is one of Europe's leading providers of life insurance and pension solutions. In Switzerland, France and Germany, the Group offers individuals and corporations comprehensive advice and a broad range of products through its own sales force as well as brokers and banks. Swiss Life provides international corporations with employee benefits solutions from a single source, and is one of the global leaders in structured life and pension products for international high net worth individuals. Swiss Life Holding Ltd, registered in Zurich, was founded in 1857 as Schweizerische Rentenanstalt. The shares of Swiss Life Holding Ltd are listed on the SIX Swiss Exchange, and the Swiss Life Group employs a staff of around 7500.
Swiss Life also owns AWD Group, which is a leading financial services provider in Europe. Insurance and third-party funds are managed by its subsidiary Swiss Life Asset Management. Due to its clear orientation, Swiss Life has an attractive and sustainable competitive position in all markets. Standard & Poor's has rated both Swiss Life Ltd, Zurich and Swiss Life, Munich, as "BBB+" with outlook "positive." S&P affirmed the "BBB+" long-term counterparty credit and insurer financial strength ratings on Swiss Life Ltd and the "BBB-" long-term counterparty credit rating on Swiss Life Holding Ltd.
Swiss Life increased its net profit by 8% from CHF 560 million in 2010 to CHF 606 million in 2011. Adjusted for one-offs and currency effects, profit from operations stood at CHF 793 million, representing a substantial improvement over the previous year's figure of CHF 751 million. This was mainly driven by the outstanding investment result, improvements at operational level and ongoing cost management. The net investment result of CHF 4.3 billion corresponds to a net investment return of 3.8%; total investment performance was at 7.4%. In addition to an excellent investment result, Swiss Life achieved further operational advances and, by 2011, had already achieved the cost targets set for 2012. The Group maintained its focus on profitability and grew in strategically important business areas.
In the words of Bruno Pfister, Group CEO, "Swiss Life negotiated a tough market environment and can look back on a successful 2011 ... Despite the historically low interest rates, our Group has grown in key strategic business areas. Going forward, we do not expect much tailwind from the financial markets. Our improved operational effectiveness, however, allows U.S. to expand our strong market position even in the current economic climate."
SRLEV N.V. provides insurance services in the Netherlands. The company was formerly known as REAAL Levensverzekeringen N.V. and changed its name to SRLEV N.V. in July, 2009. The company was incorporated in 1904 and is based in Alkmaar, the Netherlands. SRLEV N.V. operates as a subsidiary of REAAL Verzekeringen N.V., the insurance division of SNS REAAL. The group formed by SNS REAAL and its subsidiaries has a long history that is closely related to the social democratic movement and the worker's movement, and its roots lay in two insurance companies connected to those movements incorporated by the trade union at the beginning of the twentieth century. In 2007, SNS REAAL acquired Zwitserleven from Swiss Life Holdings, making it the second largest life insurer in the Netherlands.
In the first half of 2011, SRLEV, the legal entity comprising most of the life Insurance activities of SNS REAAL, successfully placed € 400 million of 30-year Tier 2 notes and CHF 105 million of perpetual subordinated notes. These transactions were part of the capital management of SRLEV and were related to the replacement of internal funding by external funding, a significant portion of which were to the Dutch government. The Supervisory Boards of SNS Bank NV, REAAL NV and SRLEV NV are composed of the same individuals as the Supervisory Board of SNS REAAL.
While Moody's currently rates these bonds at Baa2, most aspects of SRLEV's Insurance Financial Strength rating scorecard (including market position and brand, product focus and diversification, asset quality, capital adequacy, liquidity and ALM, reserve adequacy, and financial flexibility) all received the higher A rating. Weakest in the overall rating was their diversity of distribution and geographic diversification. Moody's also includes the financial flexibility at the SNS REAAL Group level in its analysis, and earnings are expected to remain under pressure, in line with expectations of constrained profitability of both the insurance and banking operations. Standard and Poor's evaluation of the strong stand alone credit profiles of both REAAL Verzekeringen N.V. and SRLEV N.V. was reduced one notch (BBB) as a result of a notional group operating rating for the SNS REAAL group.
In our opinion, SRLEV's life insurance business appeared to have a higher portion of stronger fundamentals than the parent banking group (SNS REAAL), and the additional benefit that would more normally come from the "bank guarantee" associated with this bond might actually be bringing with it the perception of added risk.
The default risk is Swiss Life and SRLEV N.V. abilities to perform. While the SRLEV debt issue does represent a higher risk than that of Swiss Life, given the sound business fundamentals and solid investment grade ratings of either issuer, it is our opinion that the default risks for these hybrid (perpetual) rate adjusting bonds is low relative to the higher yields that they offer and the currency risk of the Swiss franc.
The currency risk of the Swiss franc could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to Switzerland's economy and the policies of the Swiss National Bank.
We view these bonds as having currency risks similar to other offshore bank bonds that we have recently written about, such as JP Morgan (NYSE:JPM)'s Russian ruble bond, Bank of America (NYSE:BAC) or Lloyds Bank (NYSE:LYG) Brazilian real bonds, or UBS (NYSE:UBS) Mexican peso bonds, all of about three to five year fixed maturities.
Accessibility and Liquidity
Aside from owning various emerging market funds and ETFs that blend together various winners and losers into a mixed yield cocktail, the question arises as to how a retail investor might own or acquire individual, maturity definite Swiss franc denominated bonds. Many times broker/dealers require an institutional sized single bond purchase. However, with a broker and advisor's assistance, it is possible for a number of retail clients to be combined together in order to make a larger institutional sized purchase. Previously, we have been able to facilitate purchases as low as U.S. $10,000.
We continue to search for individual corporate instruments denominated in the currencies of growing economies that yield higher than average returns to help protect our clients against the erosion of wealth that results from a constant devaluation of the U.S. dollar. We acknowledge that a stronger U.S. dollar would directly reduce the total returns of this Swiss bond. Conversely, if the U.S. dollar continues on the longer term path of relative weakness to the Swiss franc that it has been on, this alone would add significantly to the already higher positively accruing returns of this bond.
The combination of offering a remarkably high yield, some protection against a further loss of wealth with a continuation of the U.S. dollar's weakness against the Swiss franc, and a diversification away from heavily overweight U.S. dollar based assets into one of the world's top tier fiscally conservative countries is why we are adding these bonds at this time to our Foreign and World Fixed Income holdings.
Swiss Life Coupon: 5.25
First Call: 10/04/2016
Current Yield: 5.25%
SRLEV Coupon: 7.01
First Call: 12/19/2016
Current Yield: 7%
Disclosure: Some Durig Capital clients currently own these bonds. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.