June 27, 2018 / 1:53 PM / 9 months ago

Novo Banco encroaches on AT1 zipcode with minimum 8.5% yield

LONDON, June 27 (IFR) - Novo Banco is close to pricing a Tier 2 bond, but the 8.5% minimum yield - the highest for any euro subordinated bond sold this year - reflects the level of investor caution that still surrounds one of Europe’s weakest lenders.

The no-grow €400m 10NC5 deal was announced last Friday alongside a liability management exercise (LME), together designed to rebuild the bank’s capital and reduce the interest expense of 20 outstanding securities.

Caixa Geral de Depositos’ sale of a €500m 5.75% Tier 2 (B2/NR/B+) last week should give Novo Banco confidence, but leads JP Morgan and Morgan Stanley undoubtedly have their work cut out.

The 8.5% minimum yield is more than 90bp wide of CGD’s more junior €500m 10.75% AT1 (B1/BB-/BB-/BBB), now bid at 7.58%, though inside Banca Monte dei Paschi’s €750m 5.375% 10NC5 (Caa2/CCC+), at 11%.

“I think it’s a lot more tricky than CGD,” said Filippo Alloatti, senior credit analyst at Hermes Investment Management. “They need to entice a lot of people into this trade, so they need to pay up.”

Novo Banco (rated Caa2/B by Moody’s/DBRS) was carved out of failed Portuguese lender Banco Espirito Santo, which collapsed under a mountain of bad debts in 2014. Seventy-five percent of its share capital was sold to private equity firm Lone Star last year, the first bridge bank to be privatised.

Its turnaround is lagging that of CGD, however, and it reported a net loss of €1.4bn for 2017. Its NPL ratio is still elevated at 29.7% compared with CGD’s 11.4%, while net interest income contracted by 23.3% year-on-year in 2017.

The bank has also been dogged by litigation launched by investors who suffered losses when the Bank of Portugal transferred several securities back from Novo Banco to BES in late 2015, sparking a boycott of Portuguese bond sales.

“There’s no real business plan,” said Alloatti. “However, they are showing an attempt to move in the right direction, illustrated by a desired reduction in NPLs even without stating an end-state ratio or target in their presentation.”


The LME deadline is on Thursday, with the Tier 2 pricing due to follow on Friday. Tendered bonds and new money will account for a minimum of €250m and €100m, respectively.

A successful transaction would mark a huge step forward for Novo Banco after nearing resolution last year, both proving its market access and shoring up its capital. Its total own funds ratio of 13.9% falls short of its 14% requirement.

The minimum 8.5% yield is intentionally very generous, particularly since there is limited premium built into the LME to avoid eroding capital further.

“It’s well designed to get the senior bonds out but keep new money incentivised to participate,” said a banker. “The premium is being paid in the Tier 2 [instead of the LME].”

That eye-catching yield is also a sweetener in one of the toughest issuance backdrops for years, when concessions have ramped up and execution certainty has fallen dramatically.

On that basis, some have questioned the deal’s timing. However, the bank’s management is keen to shift focus from the recap to the restructuring and hopes investors will jump at the chance to switch out of small, illiquid securities. For example, there is just €39.4m of a zero coupon note due 2045 outstanding.

The volatility may even play into Novo Banco’s hands.

“Paradoxically, the fact that the market is so difficult at the moment is a chance for them, as some people might choose to take the exit for cash or participate in the tender,” said Hermes’ Alloatti. “Some of the notes have not been performing well.”


The bank has the added comfort of a backstop bid.

As part of the conditions of sale, the Resolution Fund entered into a contingent capital agreement (CCA) that pledged up to €3.89bn to compensate for losses and maintain the bank’s level of Tier 1 for eight years.

Novo Banco has already drawn down €791.7m this year, proving the mechanism works and showing Tier 2 bondholders will in theory remain well protected.

The Fund, which maintains a 25% stake, also agreed to underwrite the €400m Tier 2 bond so long as Novo Banco had made a “best effort” to place the notes. While the bank would prefer to demonstrate market access, it will not do so at any price.

Novo Banco has also taken the unprecedented step of undertaking not to target the bonds via further LMEs for 24 months, though investor scepticism remains high after the transfer of securities in 2015.

Hermes’ Alloatti took that clause as a warning. “Reading between the lines, the message basically is: get out now because we won’t be doing anything in the next 24 months,” he said. (Reporting by Alice Gledhill, editing by Philip Wright)

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