Conflicting language between the debt offering documents and the Bermuda Monetary Authority's Tier 3 regulatory requirements raises questions about Bermuda’s regulatory treatment of assignment of capital credit for certain securities, according to Fitch.
The characteristics of securities receiving Tier 3 capital treatment from the BMA are different than those it typically encounters in other jurisdictions such as the EU, said Fitch.
“The BMA has approved Tier 3 regulatory capital credit for several companies' recent and prior senior debt offerings whose qualifying features are limited to being expressly subordinated to policyholders and where some limited restrictions are placed on redemptions,” the rating agency said.
It is “highly unusual for senior notes to receive capital credit from regulators as the failure to make scheduled interest payments or to repay principal at maturity are events of default” it added. “A missed interest payment without remedy would trigger an acceleration of principal repayment.”
In Bermuda, securities approved for Tier 3 capital treatment have no provision to defer interest payments or principal repayment at maturity, even for breach of solvency ratios. The BMA contends that companies must meet solvency ratios at all times, meaning payments at maturity are de facto subject to redemption requirements.
“In other domiciles, including Europe under EU Solvency II, subordinated debt with interest deferral features is the typical instrument issued for Tier 3 regulatory purposes,” said Fitch. “These securities also typically allow deferral of principal repayment at maturity subject to a regulatory solvency test. In these cases, neither interest deferral nor principal redemption deferral would constitute an event of default.”
European Tier 3 instruments also typically cannot be optionally redeemed prior to maturity if certain capital tests are not met or without regulatory consent or non-objection. In Bermuda, some recent bond issues have included provisions allowing for early redemption. Fitch said it does not classify this as non-performance risk since any such early redemption would only be at the company's option.
Fitch said it typically rates EU Solvency II Tier 3 securities two notches below senior unsecured debt. But in Bermuda’s case it has usually rated Tier 3 senior debt instruments at the same level as the companies' existing unsecured senior debt.
Fitch noted that the BMA has already signalled its intention to remove any ambiguity between offering document language and Bermuda regulation with respect Tier 3 instruments that will be approved in the future.
In the meantime, it warned Bermuda Tier 3 senior securities will not be included in its Prism model as available capital. This reflects the rating agency’s view that the securities lack non-performance features such as interest deferral and explicit redemption restrictions at maturity.
“Fitch will continue to monitor the evolution of Bermuda's regulatory capital regime whether securities issued are senior, subordinated or other hybrid debt, and how terms within indentures relating to priority, subordination, deferral and redemption features change over time, as per indications from the BMA that certain process changes have already begun,” said Fitch.
Bermuda Monetary Authority, Fitch, Tier 3 regulatory capital, EU Solvency II