Swiss Re leans on retail for new style hybrid

LONDON, Jan 27 (IFR) - Swiss Re became the latest issuer to go to the Swiss market to sell a new style hybrid security this week, pricing a CHF320m perpetual non-call 5.5 years issue. However, just like Zuercher Kantonalbank the previous week, the borrower had to rely on retail demand in order to get the trade away.

The issue, that qualifies as Upper Additional Capital under the Swiss insurance framework was led by BNP Paribas, Credit Suisse, Deutsche Bank and UBS. Final distribution saw 90% placed with retail clients.

This is not the first time Swiss Re has led the way in terms of innovative structures in the Swiss market. According to a banker on the trade, the borrower brought one of the first hybrid issues in 1999. This week's deal had been in the works for around six months.

Under the terms of the deal the bonds can be converted into equity at the option of Swiss Re (but not investors) at any time and the conversion will be at the then-current stock-trading price.

In order to protect bondholders in an event of conversion, investors will be made whole if they are converted. By having this option embedded in the bonds, it gives Swiss Re flexibility in terms of capital management, for example increasing its equity capital base when needed.

The bonds can also be converted into stock upon a Solvency event occurring, although unlike the Credit Suisse CoCo deal priced last year where the trigger is mandatory if the bank's common equity Tier 1 ratio falls below 7%, here it is optional. The floor price for the conversion will be set at 50% of the stock price.

Coupons are non-cumulative. Meanwhile, if not called, the deal's coupon resets to the initial spread (+672bp) over the then prevailing five-year Swiss franc swaps rate.

A large Swiss institutional investor said that while the transaction was attractively priced, carrying a coupon of 7.25% for a company that has a dividend yield below 6%, the structure was very complicated.

"Like a normal CoCo, there is a possible conversion into equity, the difference is the conversion is also at their own discretion," he said.

"It's a much more complicated structure with two legs: the conversion into equity in the case the solvency ratio goes below 100%, but also if they need the equity for, say, M&A. The problem for a Swiss franc issue is that the (institutional) Swiss franc fixed income market cannot buy into this transaction because of the conversion into equity, and because it's unrated, otherwise there could have been much more interest in terms of bookbuilding."

He added that the timing wasn't good because of the Chinese New Year, resulting in fewer Asian buyers.

Another Swiss investor said that he thought the deal would struggle a bit, citing the "too complex, too hybrid, and rather too clever for its own good" structure, which defied classification into either an equity or a bond basket for investors.

Again likening the deal to a CoCo, which he pointed out has never been tested in extremis, but with extra optionality which makes accurate risk assessment difficult, and strips the investor of both the advantages of owning fixed income securities, where you get stable cashflows, and of equity, where you get ownership and potential growth.

EDUCATION, EDUCATION, EDUCATION

Despite these comments from institutional investors, which the deal was never really targeted at in the first place, what with its lack of rating and quasi equity structure, Swiss Re did manage to get a decent size away, at least for the Swiss market, in what will surely come to be seen as a groundbreaking deal.

Guidance and final pricing of 7.25% was more than twice what ZKB offered investors the previous week. However, that SFr590m retail-driven ground-breaker was seen as a special case by many market participants, with the 100% ownership by and strong backing of the Canton of Zurich muddying the waters of where fair value should lie.

It was tighter than what Zurich Insurance paid for a USD500m perpetual non-call six and non-call 12 Upper Additional Capital trade priced in early January with a 8.25% coupon, which equated to 684bp over mid-swaps, although not by much on a swap basis, as the new Swiss Re deal equated to mid-swaps plus 672bp.

Not overly surprisingly, the vast majority of the deal went to retail clients, with early suggestions from leads being that more than 90% went to private banks/retail, with hundreds of tickets in sizes down to the minimum SFr5k denomination as "regular people" piled into the deal.

One lead stressed that the issuer and syndicate went to great lengths to educate investors about the paper, leaving a few days leeway between the roadshow and books opening to speak to investors, and that the end result was "a fantastic transaction at a fair price", especially for anyone with Swiss Re shares, as this gave a pickup to the dividend yield of the shares, and if all went badly, you still got the shares again!

(Reporting by Jon Penner, IFR Markets, Additional reporting by Martin De Sa'Pinto, Editing by Helene Durand)