REFILE-Capital raising gets more efficient as callables make comeback
(Adds missing apostrophe)
* Borrowers to reassess issuance plans
* Pricing adjusts towards more efficient capital instruments
* Investors to favour issuers with strong call track record
By Helene Durand
LONDON, Sept 27 (IFR) - Banks' attempts to meet higher capital requirements and replace old subordinated debt have been given a much-needed boost as European investor appetite for callable product returns.
A EUR1bn 10-year non-call five transaction priced this week for Denmark's largest bank Danske Bank was the latest in a recent string of deals in the callable format that have attracted strong demand from institutional investors in Europe.
"10-year bullets are more inefficient from a capital perspective," said Daniel Shore, head of Northern European FIG DCM at HSBC.
Regulators amortise the capital treatment on Tier 2 debt five years from redemption meaning, after this point, straight bullet maturities effectively become expensive bank senior debt.
With an estimated EUR180bn to be raised, mainly in Tier 2 format by 2018, the more efficient the format, the better for the bank.
Bullets became the structure of choice for banks needing Tier 2 capital after the financial crisis when issuers started to skip calls on callable bonds. From a peak of more than USD71bn equivalent issued in callables in 2006, issuance has dropped to USD15bn this year according to Thomson Reuters data.
Bond investors were left fuming when banks refused to call hybrid capital securities at the first opportunity, as had previously been the norm. These securities had been structured to provide borrowers with an economic incentive to call, so five years from maturity, typically, the coupon changed to a Libor/Euribor plus a spread. But after the crunch with senior debt expensive and rationed, and prevailing low interest rates, the incentive to call was not there.
In a lot of cases, bondholders were holding bonds where the coupon had actually stepped down, and issuers began to demand extra for including a call feature.
"The market was previously pricing a relatively hefty premium for callable versus bullets which was anything between 20bp and 30bp for low beta names," Adam Bothamley, head of EMEA debt syndicate at HSBC.
"As a result, issuers were opting for the lower-spread bullet product despite the capital inefficiency. For the best names, the problem was not really about the saleability of the product but more the breakeven."
However, pricing for callable Tier 2 debt has undoubtedly improved. A EUR750m 10-year non-call five-year for DNB Bank priced last week came at 177bp over mid-swaps, giving a coupon of 3% and was the tightest callable bond priced since the financial crisis began.
Meanwhile, bankers on the Danske deal, which was led by Barclays, Credit Suisse, Danske, HSBC and Societe Generale said the issuer did not really have to pay up to add the call.
Bothamley added the catalyst for the narrowing of the call premium had been the recent rate volatility and the back-up in US Treasury yields.
"Investors now value the rate protection afforded by the reset so 10NC5 works well," he said. "Also, by having a one time call and coupon reset, investors feel they are not giving too much away in terms of optionality to the issuer."
HSBC's Shore added that the success of the recent supply could make issuers reassess their capital issuance plans and whether they should accelerate them as Tier 2 is still an important part of the capital stack.
"If the recent deals perform and markets remain in good shape then this could open up opportunities for banks who have traded at a much higher spread."
The depth of the demand has also played a key part. "The market has been deeper for bullet trades than for callables, but that is less true now," said Piers Ronan, FIG syndicate at Credit Suisse. "Investors are not so keen on duration and we have now had four callable deals in a row from banks that have worked very well."
Demand for HSBC, Credit Suisse, DNB Bank and Danske Bank, all priced in September, was in excess of EUR3bn each. The fact that asset-managers, pension funds and insurance companies are prepared to buy the product is also another positive for banks. But it won't be a one way train for borrowers.
"Some issuers will find it easier than others to access the format," said one London-based fund manager. "The Scandis and the likes of HSBC who have a strong track record of called deals will find it easier than others who have not kept their side of the bargain and not called deals when they could have done." (Reporting by Helene Durand; Editing by Alex Chambers, Marc Carnegie)
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