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“Temporarily the US institutional market is less receptive to perpetual issuance. That's one of the reasons why more deals are going into US retail”
Sid Prasad, Merrill Lynch |
Market participants’ hopes that some clarity would emerge from a conference call held in mid April by the National Association of Insurance Commissioners’ Securities Valuation Office (SVO) on its classification of hybrid securities were dashed. The NAIC merely informed participants of its general practice on classifying securities. Many market participants expressed frustration about the continuing impact the NAIC’s decision to classify Lehman’s ECAP as common equity is having [US hybrids: Should we panic over ECAP?, Euromoney, April 2006].
That decision was made following the US insurance regulator’s observation that insurance companies were reporting trust preferreds and other hybrids as bonds, something that it was apparently unhappy about. There are three capital asset categories in which insurance companies can place their securities investments – debt, preferred equity and common equity. Insurance investors are required to hold significantly greater amounts of capital against common equity than against preferreds or debt.
Flexibility
Much to investment bankers’ chagrin, the NAIC has not provided much clarity on the exact rationale for its decision on ECAPs. It did offer up a framework guide analysis but then said it did not determine completely final classification, saying that the framework concepts have to be interpreted flexibly.
The NAIC did suggest that participants use a process called the emerging instrument vehicle to obtain an opinion. But it readily admitted that this would not be a timely procedure.
Avenue
“This is going to run and run,” says an origination official. “I gather there are four pending new issues striving for instrument designation in addition to those being reviewed. There is no chance that they get guidance until SVO decides what principle it is working toward. So it feels like that avenue will be closed for the foreseeable future.”
“The question is whether there is something in the new breed of hybrids, such as the mandatory trigger, that is causing the SVO to classify the instruments as common equity, or whether the SVO has fundamentally changed the way it evaluates hybrid securities. If it's the latter, then execution of large hybrid transactions in the US institutional hybrid market may continue to be challenging for the foreseeable future,” says Peter Jurdjevic, European head of the global fixed income new products at Citigroup.
Shut
The decision has effectively shut the US institutional investor market for hybrids issuers. Last month USB Capital opted for retail investor distribution for its hybrid transaction that closed in early April via Citigroup, Merrill Lynch and Morgan Stanley. BNP Paribas also decided that the US market was not worth the risk for its recent hybrid tier 1 outing.
“Every time we look at a transaction we take a view on pricing and execution risk. The sterling fitted both criteria,” says Fred Zorzi, co-head of syndicate at BNP Paribas. The bank sold £450 million of perps in addition to a €750 million tranche. “We did not think there was enough clarity on the US institutional market.”
This is despite the fact that the market has rebounded somewhat from the widening seen in the immediate aftermath of the NAIC’s decision.
"Spreads have retraced from the wides seen at the start of the NAIC classification issue but are still circa 10bp back from the all time tights seen earlier in the year," says Sid Prasad, head of FIG capital markets at Merrill Lynch. But these are theoretical spreads Prasad argues. It is far from certain on what could actually get done.
Something like 100 securities have been put forward by insurance investors for re-confirmation.
“Temporarily the US institutional market is less receptive to perpetual issuance. That's one of the reasons why more deals are going into US retail,” says Prasad. Aside from Lincoln National, Barclays Bank has recently sold $675m of tier 1 securities to US retail investors. “I suspect that ultimately the SVO will revert to a preferred designation under a more granular evaluation framework,” says Jurdjevic. But Jurdjevic does not expect the wider issue to be resolved quickly.
Backburner
The fact is that no one knows what the NAIC SVO is really thinking. It refused to say why it views Lehman’s ECAPs as common equity, saying that such decisions are only explained to the specific holders of that paper. The US institutional market has traditionally been the largest pool of capital for hybrids and responsible for purchases of $29 billion and $35 billion in 2004 and 2005.
The general thinking appears to be that deals slated to go to this market have been put on the back burner or redirected to other investment pools.