We commented yesterday on the rise in triple B spreads. Today, the FT mentions the rise in investment grade spreads as a whole (see chart above).
And now to comment briefly on the Just 2019 annual report.
There are two points to note. First, see table below, both statutory and Solvency II capital have improved.
| RECONCILIATION OF IFRS SHAREHOLDERS’ NET EQUITY TO Solvency II own funds (Unaudited)m | 2019 | 2018 | diff |
| Shareholders’ net equity on IFRS basis | 2,321 | 1,664 | 657 |
| Goodwill | -34 | -34 | 0 |
| Intangibles | -120 | -137 | 17 |
| Solvency II risk margin | -873 | -851 | -22 |
| Solvency II TMTP | 1,891 | 1,738 | 153 |
| Other valuation differences and impact on deferred tax | -1,271 | -793 | -478 |
| Ineligible items | -35 | -6 | -29 |
| Subordinated debt | 684 | 590 | 94 |
| Group adjustments | -1 | 1 | -2 |
| Solvency II own funds | 2,562 | 2,172 | 390 |
| Solvency II SCR | -1,814 | -1,595 | -219 |
| Solvency II excess own funds | 748 | 577 | 171 |
But it’s not clear how they improved it. There is a rise in the transitional measures, a form of fake regulatory asset that has to be ‘paid back’ over 12 years (although the present value of the ‘repayments’ is never recorded as a liability on the regulatory balance sheet). Then there is the mysterious ‘other valuation differences’ that jumps by half a billion. Regular readers will recall I discussed this mystery in August 2018. The implication is that what the firm gains by the fake regulatory asset has no correlate in the statutory balance sheet, which does not allow fake assets (although it does allow understated liabilities), so changes in TMTP will tend to be offset by changes in the other valuation differences. I tried to get some sense out of the firm (and from their then auditors) in 2018 but without success.
The second point is how earnings were supported by change in investment income.
p.15: “Net investment income: Net investment income increased from £142.6m to £1,451.7m in 2019. The main components of investment income are interest earned and changes in fair value of the Group’s corporate bond, mortgage and other fixed income assets. During 2019, risk free rates have decreased and credit spreads have narrowed, giving rise to unrealised gains on the Group’s mortgage and corporate bond assets. This is in contrast to the prior year, where risk free rates increased and credit spreads widened, leading to unrealised losses.”
But of course (see chart again) any narrowing in spreads can be reversed by a widening, perhaps a significant one!
There was a loss on the liability side:
p.15: Change in insurance liabilities Change in insurance liabilities was £2,237.8m for the current year, compared to £1,689.0m in 2018. The increase compared to 2018 mainly reflects the growth in gross insurance liabilities due to the change in valuation interest rate, driven by the fall in risk-free rates as noted above.
But this is unlikely to be reversed, as what we are seeing in the current crisis is a flight to quality. The 30 year gilt, at 1.1% a month ago, is now 0.7%. So firms with an asset-liability exposure like Just Group (and there are many of them) are currently hit on both sides: widening credit spreads that drive asset values down, narrowing gilt yields that drive liability values up. Quite the wrong way to be driving.
Underlying all of this is the question of why the regulators ever allowed such balance sheet structures in the first place. The situation is certainly not consistent with probabilities of default of 1 in 200.
Or rather, since Just’s capital ratio is 141%, 1 in 7,100 years.