October 7, 2016 / 2:17 PM / a year ago

Fitch: NN Move for Delta Lloyd Suggests S2 Will Drive M&A Pickup

(The following statement was released by the rating agency) LONDON, October 07 (Fitch) NN Group's takeover approach to Delta Lloyd reinforces Fitch Ratings' expectation that M&A activity in European insurance will accelerate as well-capitalised firms seek growth through acquisition of rivals hit harder by Solvency II. Delta Lloyd, which has rejected the approach, was particularly heavily affected by S2 due to the combination of its business mix and capital management strategy with a relatively tough stance on implementation by the Dutch regulator. This drove a sharp decline in the insurer's share price as it had to raise fresh cash through a rights issue. NN's strong capitalisation makes it well placed to realise further capital benefits by expanding its Dutch market position. Saturated markets in most big European countries and generally weak profitability make organic growth difficult and mean buying market share is likely to be an attractive option for some insurers. Firms' capital calculations can also benefit from diversification under S2, meaning the combined solvency position following an acquisition could be significantly higher than a simple weighted average of the two firms' S2 ratios. We believe firms with limited diversification or those skewed to business harder hit by S2 capital requirements are the most likely targets. Smaller insurers in particular face a greater burden from the sharp increase in costs associated with S2. Smaller firms are also likely to have fewer options for raising fresh capital if S2 ratios weaken. A cut in the ultimate forward rate would increase the potential for M&A by putting further pressure on S2 ratios. This rate is used to extrapolate the forward curve for valuing liabilities that have a long duration. A decision by the European Insurance and Occupational Pensions Authority on whether to cut the ultimate forward rate from the current 4.2% has reportedly been delayed until next year. M&A can be credit positive if it increases diversification and market share and leads to economies of scale, but depending on the way deals are structured it can also significantly increase financial leverage. Execution risks such as failure to realise expected cost synergies, lower profits than forecast, poor integration of businesses and systems, and subsequent strategy changes leading to losses on disposal can also be overriding rating factors. We believe that the benefits to NN's credit profile from improved market position, capital synergies and cost efficiencies following an acquisition of Delta Lloyd would broadly balance the negative factors, including higher leverage. We therefore would not have expected a deal based on the terms of the rejected approach to affect the firm's 'A+'/Stable rating. But if a revised offer led us to expect NN's financial leverage ratio would be above 30% for a sustained period this could put downward pressure on NN's ratings. Contact: David Prowse Senior Director Insurance +44 20 3530 1250 Fitch Ratings Limited 30 North Colonnade London E14 5GN Willem Loots Director Insurance +44 20 3530 1808 Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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