BPE CoCo debacle puts investors in driving seat

Fri Jul 11, 2014 10:21am EDT

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* Pulled BPE CoCo sends jitters through market

* Investors hope for market discipline around pricing

By Aimee Donnellan

LONDON, July 11 (IFR) - Turmoil surrounding Portugal's Espirito Santo Group forced Banco Popular Espanol to yank its CoCo bond from the market on Thursday, handing investors a strong bargaining chip to demand higher prices on future deals.

On Thursday morning, Spanish lender BPE began marketing a perpetual non-call five Additional Tier 1 at 7%-7.25% only to cancel the transaction mid execution as the bank capital market began to drop thanks to the spillover from Portugal.

"BPE has made the market very nervous," said a syndicate banker.

"This has completely transformed the way CoCos will now be priced as investors now really have the upper hand," said another.

Up until now, investors have had little choice but to buy into tightly priced contingent capital transactions as a ferocious market rally drove yields down by as much as five percentage points.

This meant that for investors who stayed on the sidelines, avoiding the potential risks of coupon deferrals, write-down or equity conversion, they were missing out on the biggest trade of the year.

"CoCo prices were really wound in, but I think what's happened with BPE will reprice everything for a while," said a banker involved in the transaction.

"It may not be a bad thing to have a bit of volatility in the market because there were a lot of question marks about how sustainable the whole situation was."

BPE was not the only issuer to fall victim to market volatility on Thursday as Spanish construction firm ACS was also forced to pull its proposed 500m five-year bond.

From an investor point of view, the prospect of a market repricing is welcome as the situation surrounding BES has also led some to question the foundation of the European recovery.

"It would be very useful to have some more pricing discipline brought back into the Additional Tier 1 bond market," said Satish Pulle, lead portfolio manager at ECM Asset Management.

"Overall the eurozone recovery is much more fragile than we thought. High levels of non-performing loans, a weak economic picture and low levels of capital in banks is why the ECB is considering launching a quantitative easing programme."

NO CRYSTAL BALL

Other bankers involved in the BPE transaction tried to play down some of the future impact of shelving the bond. "I don't think this is a permanent impairment," said one.

Another suggested that the only impact would be to reduce order inflation for AT1 deals.

BPE was targeting as much as 750m of AT1 capital. The deal would have converted into equity if the bank's common equity Tier 1 ratio fell below 7%.

Together with a 500m low-trigger CoCo issued in October, a 750m sale on Thursday would have filled the bank's 1.5% capital requirements bucket on the basis of around 84.5bn of risk-weighted assets, according to CreditSights.

Another banker explained that at the time the bond was announced there was enough demand to price a benchmark transaction but the deal was temporarily put on ice to ensure future secondary performance.

"This was the worst day in the market so far this year, but it started out in a neutral tone," he said.

"For those that are criticising the execution of this deal I would ask them if they could have predicted that BES's shares would have been suspended," said another banker.

But there has long been concern in the investment community that prices for AT1 paper were getting too tight and were not covering the risk.

Coupon payments on AT1 instruments are fully discretionary, and once they have not been paid, are lost forever.

Furthermore, AT1 instruments are subject to profit distribution restrictions once a bank begins eating into its capital conservation buffers, which prevents it from making discretionary distributions.

These risks have long been in the background but now are coming to the fore. Some believe that there needs to be further retreat in the CoCo market for it to get back to a where investors feel comfortable.

"I think it will take a bigger shake out to get AT1 levels back to what seems like adequate protection for the risks," said Pulle. (Reporting by Aimee Donnellan; editing by Matthew Davies)

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