BPE success gives hope to Europe's banking weaklings
* More than EUR1.5bn of demand for Europe's first AT1
* Issuers to raise EUR300bn in the format in coming years
* Work still needed to get fixed income investors on board
By Helene Durand
LONDON, Oct 4 (IFR) - Banco Popular Espanol opened a new avenue for weaker credits looking to plug their capital holes this week when it priced the first contingent convertible Additional Tier 1 issue in euros. But as the trade showed, the sale of these instruments will neither be easy nor cheap.
The Spanish lender printed a EUR500m perpetual non-call five-year deal with an 11.5% coupon via Bank of America Merrill Lynch, Barclays, Santander and UBS.
As a result of the deal, the bank's Tier 1 ratio increased by 57bp to 11.03%.
Under Basel III, banks will need to have a minimum 8% total capital, comprising 4.5% Common Equity Tier 1, 1.5% Additional Tier 1, and 2% Tier 2.
Recent data from the Bank for International Settlements in Basel showed that banks in the European Union had a EUR70bn capital shortfall - not great news with another round of stress tests coming next year.
Analysts at Barclays believe that based on total EU banking system risk-weighted assets estimated at around EUR20trn, banks could have to raise as much as EUR300bn in Additional Tier 1 capital in the coming years.
However, because Additional Tier 1 instruments that meet the new regulatory framework are particularly risky from an investor point of view, there has been considerable doubt whether they would prove attractive to potential buyers, especially when it comes to deals from non-national champions in weaker jurisdictions. If such deals prove impossible, it would leave those institutions with very few options to boost their capital.
In the case of BPE's new deal, not only can the bonds be converted into equity if the bank's Common Equity Tier 1 falls below a certain level, but the issuer has full discretion on paying coupons, and can stop payments even if it continues with dividends to equity holders.
Investors also run the risk of seeing coupons being switched off at the discretion of the regulator.
"Peripheral Additional Tier 1 is not going to be everyone's cup of tea but the deal shows that there is depth of demand and that the asset class is very much open for business," said Ed Mulderrig, FIG syndicate at UBS. "Issuers who may have been thinking of Additional Tier 1 as something for further down the line will now be re-thinking their plans."
The transaction ended up with an order book over EUR1.5bn. That's a positive sign for the asset class, although the fact that 40% of the trade was sold to hedge funds suggests that some fixed-income investors are still struggling to warm to the product, with one saying that he struggled to understand why any investor would want to run such risks. Around 48% of the bonds went to fund managers.
UBS's Mulderrig said there were many reasons why investors got involved. "Some accounts see Spain as the next recovery story following Ireland and see BPE as a leader away from the national champions," he said. "The size of the deal and strong book should support performance going forward."
Spanish banks are recovering from a financial crisis triggered by a 2008 property crash, which left some with gaping capital holes after the government last year enforced writedowns on real estate holdings.
BPE announced at the beginning of the year that it had made EUR9.6bn of provisioning against losses, causing an accounting loss of EUR2.461bn for 2012. It remains deep in sub-investment grade territory at Ba3/BB-/BB+. The new bonds themselves were not rated, but given the way that such deals are notched down by the rating agencies relative to senior debt, they would have been rated at Triple C.
BPE ended the second quarter of this year with a core capital ratio of 10.28%, comfortably above a minimum European Banking Authority requirement of 9%, while its Tier 1 ratio was 10.46%. For the bank to break the 5.125% Common Equity Tier 1 trigger for the bonds to convert into equity, it would have to make EUR4.7bn of losses.
CHEAPER THAN EQUITY
Boosting its overall Tier 1 ratio did not come cheap, however. The gap between senior and Additional Tier 1 is huge, with a banker on the trade saying a new senior would price some 725bp inside the AT1's 11.5% yield, while a covered bond would come some 865bp tighter. BPE's deal was also around 400bp back of where a top-tier bank would do this type of trade.
"I think it is clear that AT1 will play an important part in bank capital under CRD IV," said a senior treasurer at a Spanish bank, referring to the EU's latest capital requirements directive. "So it makes sense to use it and avoid further dilution to the current equity holders."
"What I consider challenging is the cost: 11.5% means almost EUR60m in dividends every year."
The debt is tax-deductible, however, so the bond's true cost is around 8%, versus an estimated 10.5% for equity. The bank already made a EUR2.5bn cash call last year, making it difficult to come back for more equity.
"There are not many alternatives when it comes to raising capital," said a banker. "The cost of raising equity is high, and there is the dilutive impact."
The transaction was quoted at 100.30/100.40 on Friday morning, having priced at par. (Reporting by Helene Durand, Additional reporting by Aimee Donnellan, editing by Matthew Davies, Julian Baker)
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