At the end of August, Société Générale successfully completed only the second additional tier 1 capital deal from a European bank designed to comply with new capital requirement regulations and the first since the European Banking Authority clarified technical standards at the end of July.
Unlike the previous deal, from BBVA in the spring, which had multiple triggers, Société Générale went for a much simpler structure with a single low trigger for write-down in the event the bank breaches a 5.125% threshold on its Basle III common equity tier 1 ratio. This stood at 9.5% as the bank entered the third quarter, so that looks a remote possibility. Investors prepared to take the risk of it coming to pass are rewarded with an 8.125% coupon on the par issued bonds. That was enough in these days of ultra-low rates to attract an order book of close to $4.5 billion for the $1.25 billion perpetual.
Asian private banks were big buyers of the first-generation contingent convertibles banks sold in the first years after the financial crisis. On this latest bank hybrid deal, the book comprised 90% European demand, with institutional investors allocated 70% of the bonds, hedge funds 10% and private banks the rest. This first deal establishes the strength of demand from conventional real-money credit funds.
The structure wasn’t to the taste of all investors. Although fixed-income investors do not face a permanent write-down, or conversion into equity that their mandates don’t permit them to hold, their chances of a write-up and restoration of coupons would depend entirely on Société Générale’s willingness to make such payments after a return to profitability.
The capital rules as clarified by the European Banking Authority stipulate that to count as capital, bonds must write up entirely at the issuer’s discretion. A contractual undertaking to write up would render bonds ineligible to qualify as capital.
The success of this first new deal, as well as setting a potential template for other issuers waiting in the wings – Deutsche Bank and Barclays have both made public their intention to issue additional tier 1 – offers a reminder of the potential for a large new bank capital market to grow quickly now.
|Stéphane Landon, head of group ALM and treasury at Société Générale|
Although some investment banks have talked up the potential for a flood of new issuance, it’s worth remembering that much of this might be refinancing or replacing older deals, rather than net new supply.
Landon suggests that one reason investors might have for trusting banks’ intentions to opt to write back following a return to profitability after any write-down of additional tier 1 bonds is that they will need to maintain access to the tier 1 capital market.
At the start of September, Bank of England governor Mark Carney, speaking as chair of the Financial Stability Board, reminded international regulators that as part of their effort to end distortions in the financial system that protect too-big-to-fail banks, an essential condition is that "cross-border cooperation agreements must be struck, and policies for gone-concern loss-absorbing capacity should be developed". Regulators want banks to build additional tier 1 capital buffers equivalent to 1.5% of their risk-weighted assets, implying a market in the hundreds of billions.
Institutional investors have been sceptical about contingent convertibles, arguing that they potentially subvert the capital structure by imposing big write-downs on bondholders while allowing equity investors the hope of a restoration of dividends and the chance for capital to appreciate again in a recovery.
And although the new temporary write-down structure is clearly better than a permanent write-down deal, some bond investors still harbour doubts as to how they might fare through a crisis compared with supposedly junior equity investors.
Antoine Loudenot, head of capital structuring at Société Générale, says: "When thinking about the likelihood of a bank restoring coupons and writing up, investors should look to the exemplary track record of Société Générale as an issuer in calling its perpetual tier 1 and tier 2 bonds on their first call dates stretching back through the financial crisis."
Landon adds: "One reason we went for a write-up structure rather than a convertible was an effort to align future capital deals with similar older transactions. Back in 2012, when the group suspended dividends in an effort to build up its capital, we still paid coupons on similar bonds."
There are legal jurisdictions – Russia, a country seeking to move its banks rapidly towards Basle III implementation, is one – where banks might not be allowed to go back on debt write-offs and restore obligations.