Antonello Aquino, Associate Managing Director at Moody’s
We also view the IPO, which AXA intends as a first step towards a full sale of the US business, as positive for the group's economic capitalization and risk profile. We currently regard AXA's economic capitalisation as of lower quality than that of some Aarated peers.
This is because its reported Solvency II ratio is significantly inflated by the use of regulatory equivalence for the US business. The IPO will therefore make AXA less reliant on equivalence and improve the group's overall risk profile, a credit positive. The US life business, which accounted for close to 20% of group underlying earnings as at YE17, holds liabilities related to a legacy portfolio of variable annuities (VA) with guaranteed benefits, which can have a material adverse effect on earnings and capital in some stress scenarios.
Going forward, a full sale of the US business, in combination with the XL acquisition, will accelerate AXA's ambition of becoming more reliant on non-life underwriting profit and less on financial market-related earnings. The XL acquisition will also help AXA counterbalance reduced earnings diversification following the sale of its US business. With the IPO and exchangeable bond proceeds (€3 billion) in addition to cash at hand (c.€3.5 billion), subordinated debt raised (€2 billion out of c.€3 billion initially targeted) and pre-IPO reorganization transaction proceeds ($3.2 billion including internal loan repayments), AXA has now secured over €11 billion of the €12.4 billion required to fund the XL acquisition.
Furthermore, the IPO and exchangeable bond proceeds could increase by up to around $0.5 billion if underwriters exercise the option to purchase additional amounts, and AXA could issue up to another €1 billion in subordinated debt. Therefore, the execution risk around the XL financing, and any need for AXA to tap into its back up bridge financing, has largely been removed. More negatively, AXA US, as part of its preparations to operate as a stand-alone business, has increased its external debt (increase in senior debt partially offset by reduced commercial paper) by around $2.8 billion on a pro-forma basis as at YE17.
This debt, at least in the short term, will be fully consolidated onto AXA’s balance sheet, thus increasing group financial leverage. Leverage, as calculated by Moody's, will also increase slightly as a result of the exchangeable bond (mandatorily exchangeable for shares in AXA's US holding company, AXA Equitable Holdings, Inc.,).
The bond carries a high coupon of 7.25% (corresponding to the premium conversion price), which will pressure earnings coverage, although AXA will receive dividends from the AEH underlying shares which it will continue to own and the instrument is relatively short-dated, expiring in 2021. Taking account of the XL acquisition, we estimate that AXA’s adjusted financial leverage has increased to close to 30% from 24% on a pro-forma YE17 basis. In mitigation, AXA is targeting a reduction in its debt gearing from c.32% to below 28% within two years (including the US IPO related debt issuance). We assigned a negative outlook to AXA following the announcement in March 2018 of its proposed acquisition of XL. While the proceeds from IPO reduce the funding risk of the acquisition, before any stabilization of the outlook, we would want to:
Evaluate the future performance and balance sheets of the combined AXA and XL to assess the likelihood of: 1) adjusted financial leverage remaining below 30% on a sustained basis; 2) the Solvency II ratio remaining comfortably within AXA's target range of 170-230%.
See a smooth integration of XL’s business, with key senior XL management and underwriting personnel remaining in post following the closing of the transaction.
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