Idea of the Week: Bonds yielding over 7% from a fast-growing Asian insurance provider

About FWD Group

(In this article, unless otherwise stated, dollar values are in USD, growth rates are YoY, and figures are as of FY23.)

FWD Group Holdings Limited (FWD) is a pan-Asian life insurance company. It was founded in 2013; since inception, it has expanded quickly across Asia into 10 markets with over 13 million customers (as of 31 Dec 2023).

Its majority shareholder is Pacific Century Group, a private investment group chaired by Richard Li. Various news sources have recently reported rumours of FWD’s plans for an IPO in Hong Kong, though these rumours have not been officially confirmed by the company.

We previously provided coverage on FWD in the linked articles below. This article will provide updated coverage of FWD as of FY23 (31 Dec 2023), with data also taken from its 1Q24 (31 Mar 2024) business update where relevant.

Related article: FWD Group announces 10Y USD senior unsecured bond at IPG of T + 290 bps

Related article: FWD Group announces tender offer for their 5.750% bonds due 2024

Related article: FWD files for US IPO – this is a good time to buy its USD perps yielding 6%

Solid growth pace for FWD

Annualised premium equivalents (APE), a metric of new business sales, grew by +17% to $1,646m (Chart 1). Meanwhile, value of new business (VONB), a metric of new business profits, grew by +20% to $991m. We provide a quick geographical breakdown of VONB in Table 1 below. With VONB climbing faster than APE, new business margins improved from 56% to 58%.

Despite the strong growth in APE and VONB, new business contractual service margins (CSM) dipped slightly by -6% to $1,349m. However, the dip in this new business CSM was primarily due to changes in operational assumptions particularly discount rates, rather than an actual slowdown in FWD’s business. Taking these three metrics (APE, VONB, new business CSM) together, FWD’s business continues to demonstrate growth at a solid pace, notwithstanding changes in certain operational assumptions.

(Note: VONB and new business CSM are both profitability metrics but with different assumptions. Management previously shared that CSM is based on current risk-free rates while VONB is based on long-term interest assumptions, with the former likely to be more volatile.)

Chart 1: Business Growth

Table 1: Breakdown of VONB

Operating / financial highlights

Turning to operational performance, FWD’s net insurance service result improved by +9% to $584m, helped by a larger CSM release (insurance revenue minus insurance service expenses) of $608m. Meanwhile, FWD also recorded a higher (positive) net investment result (FY22: $246m / FY23: $308m). Together, these contributed to a solid operating performance, as adjusted operating profit after tax (OPAT) grew +40% from $220m in FY22 to $307m in FY23 (Chart 2) with all four geographical segments delivering positive OPAT.

Despite the solid operating performance, FWD still recorded net losses of -$717m for FY23 due to multiple non-operating items (FY22: -$320m). The largest driver (Chart 3) was a strategic reinsurance transaction with Athene conducted in Nov 2023, which had a -$505m one-time impact on accounting profits. However, management has highlighted several longer-term benefits of this transaction, including an additional +$440m in new business CSM (which will eventually feed into profits across subsequent years) and an improvement in FWD’s capital position. Excluding this -$505m impact and the -$235m impact from bond disposals, FWD’s net income would have been roughly flat.

(Note: The reinsurance transaction involves Athene reinsuring an in-force block of whole life insurance policies from FWD Japan. FWD management stated this was a move to improve its capital position while also delivering economic benefits.)

Chart 2: Operating Performance

Chart 3: Net Income / Loss ($m)

Outlook and Risks

We expect FWD’s revenues and profits to grow steadily over the medium to long term. This stability can come from the fact that a sizeable proportion of revenues is derived from the release of CSMs over time; FWD’s growth potential will likely come from the strong momentum observed in FWD’s business and operational aspects (described in previous sections).

With that being said, we reiterate that FWD was unprofitable in FY23, and was also in the red in FY22 and FY20. Nonetheless, as highlighted above, a big part of FWD’s unprofitable FY23 was due to a one-time transaction (Athene), and this transaction would deliver stronger profitability over time through the release of CSM. Overall, we think that FWD is still on the path to profitability by FY25.

Credit highlights

FWD’s capital position currently looks strong. We first look at its solvency ratio, which is one of FWD’s most important ratios, as authorities (the HKIA) may intervene below a ‘Prescribed Capital Requirement’ (PCR) level. FWD’s solvency ratio improved slightly from 288% in FY22 to 292% in FY23, with a sizeable buffer of $6.0b over the PCR of $2.1b.

We also think FWD’s investment portfolio has a relatively prudent composition. Debt securities account for 70% of its $44b investment portfolio, with about 7% into either cash or loans & deposits, and the remaining 23% or so in funds, equities, and others (Chart 4). Furthermore, the credit quality of its portfolio remains decent. 92% of its debt securities holdings are considered IG-rated. In addition, we proxy ‘safer’ holdings by adding up (i) IG segments of debt securities; (ii) IG segments of loans & deposits; and (iii) cash and equivalents, and find that about 70% of its portfolio can be considered ‘safer’ based on this calculation.

On the other hand, FWD’s leverage ratio worsened from 23.6% in FY22 to 27.2% in FY23, though we think there were a few factors in play, including the pre-financing of notes due in Sep 2024 (25.6% excluding this), and potentially lower equity levels as a result of market disruptions in Vietnam. We acknowledge this recent worsening in FY23 but think FWD’s leverage ratio remains very manageable.

Chart 4: Portfolio Breakdown

Recommendations

We list FWD’s outstanding USD-denominated bonds in Table 3 below, excluding some of its 2024 bonds given the very short time to maturity.

As a start, we highlight the differences in seniority between FWD’s bonds: (i) the Dec 2033 bonds are senior unsecured and the highest-ranking of these FWD bonds; (ii) the 6.375% perpetuals and Jul 2031 subordinated bonds are the next highest ranking (senior subordinated); and (iii) the Apr 2029 bonds and other perpetuals will be the lowest ranking of these FWD bonds (subordinated). The differences in seniority can generally be observed through the different Moody’s ratings assigned to each bond.

We first do not recommend FWD’s various perpetuals because they come with non-call risks, especially considering FWD does have a history of not calling its perpetuals. They also come with standard coupon deferral and dividend stopper clauses, with the 6.675% perpetuals having a non-cumulative coupon deferral clause. On the other hand, these perpetuals do come with change of control calls (with a 500bps step-up if the call is not exercised) unlike the non-perpetuals, but we do not think this is particularly relevant today.

Instead, we recommend FWD’s subordinated bonds, namely FWDGHD 8.400% 05Apr2029 Corp (USD) and FWDGHD 7.635% 02Jul2031 Corp (USD), with a preference for the former Apr 2029s, as we think the yield pickup for each level of seniority (6.29% vs 6.92% vs 7.46%) justifies the subordination risk. The shorter tenor of the Apr 2029s is also a plus for us, considering the (i) lesser uncertainty with the shorter maturity profile and (ii) shorter duration profile in a higher-for-longer rates environment.

Furthermore, these FWD bonds provide a decent yield pickup compared to bonds from peer issuers (Table 2). We provide some examples below.

• Ping An Insurance: The four bonds we listed in this table are all senior unsecured and rated Baa2, but still offer significantly lower yields compared to FWD’s Dec 2033s which have the same rating. In any case, FWD’s exposure is more regional (in Asia) compared to Ping An which is more concentrated in China.
• AIA: Even though AIA is a better-established franchise (compared to FWD) and has a stronger credit profile, its bond yields look comparably less attractive in the low-mid 5%s for senior unsecured bonds and mid-high 5%s for the subordinated bonds.

Table 2: Recommended bonds (bolded)

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.

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