Market on tenterhooks as BPE preps debut euro AT1
* BPE to open euro market for Additional Tier 1
* Pricing key to determine value versus equity
* Investors to focus on extent capital buffer from trigger
By Helene Durand
LONDON, Oct 2 (IFR) - Institutional investor response to Banco Popular Espanol's planned contingent convertible issue will be key to determining whether the eurozone's weaker banks can meet stringent capital regulations in a cost-efficient manner.
The EUR500m deal will be the first Additional Tier 1 in euros and the first from a sub-investment grade bank in any currency, but early chatter is that it will have to pay over 11% to clear.
It could price as early as this week, via Bank of America Merrill Lynch, Barclays, Santander and UBS, and if successful, may open the door for a raft of weak institutions to boost their capital base.
The results of a Basel monitoring exercise published last week showed that banks in the European Union had a EUR70bn capital shortfall.
Buyers of the security, which will be perpetual non-callable for five years, will be converted into equity if BPE's Common Equity Tier 1 ratio falls below 5.125% or if its Tier 1 ratio falls below 6%. The latter trigger becomes redundant from January 2014.
Popular ended the second quarter of this year with a core capital ratio of 10.28%, comfortably above a minimal European Banking Authority requirement of 9%, while its Tier 1 ratio was 10.46%.
"As always with these trades, one of the main questions is how big the buffer is between the capital level and the trigger and how aggressive the bank has been on its risk-weighted assets and provisioning," said a banker.
"Spain has been one of the most aggressive countries in terms of provisioning and banks are not allowed to skimp on RWAs."
He added that BPE would have to lose EUR4.5bn for investors to face conversion. "Unlike a Barclays or Credit Suisse, BPE does not have a big trading platform or big investment banking operation."
"Anyone buying the deal is taking a view on Spain. The buffer is over 4%, and while it might seem small in comparison to other CoCo deals we have seen, it is big on a relative basis, taking into account the size of the bank."
He added that even if the trigger was hit, investors would not be losing their shirts. "They get converted into equity and can have a ride in the recovery of the institution," he said. The floor for the conversion is 50% of the share price at issue, which is currently around EUR2.
While some believe Popular is not currently short of capital, researchers at Goldman Sachs, who recently ran their own stress tests on Spanish banks and their property exposures, estimated that Popular could have a EUR3.7bn capital shortfall under EBA requirements.
Meanwhile, Spain continues to suffer from the effect of the financial crisis with the youth unemployment rate hitting 56%.
"It will pique other weaker issuers' interest although we still expect most of the supply in Additional Tier 1 to come from national champions," said one banker not on the deal.
This is because investors are relying mostly on trust that the borrower will keep on paying coupons, he added.
Another said he was surprised to see the deal ahead of a national champion.
"The small size and relatively easy to understand structure are positives, but the fact that they wall-crossed investors could play against them as they will have committed to allocate those investors based on a certain price and they won't really be able to tighten guidance," he said.
And where the deal prices is key. Market chatter was indicating BPE may have to pay a coupon as high as 11.25%-11.75%, although some believe that something just above 11% will be enough.
Others said they had heard investor feedback is as high as 12%, which begins to look expensive versus the cost of pure equity capital, although AT1 coupons will be tax-deductible.
BPE is rated Ba3/BB-/BB+, although the new AT1 deal will be unrated. In May, BBVA priced a USD1.5bn perpetual non-call five-year AT1 which was rated BB-, four notches below its senior rating. If the same notching was to be applied to BPE, the deal would carry a CCC+ rating.
"Investors are not buying this stuff to get in their investment-grade portfolio and they have portfolios set up where they can put unrated, equity convertible deals," a banker said. "BPE paid on its hybrids during the crisis and that counts for a lot for this type of deals."
(Reporting by Helene Durand, editing by Alex Chambers, Julian Baker)
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