Last month a slew of European banks issued 10-year bullet maturity Basel III-compliant, tier-2 (B3T2) subordinated bond deals, as they sought to grow a new market for these lower cost total loss-absorbing capacity (TLAC)-eligible instruments. Deutsche Bank attracted a €4.4 billion order book for its €1.25 billion deal priced at 210 basis points over mid-swaps. BNP Paribas drew €5.5 billion of demand for its €1.5 billion offering at 170bp over, while Société Générale took €3.8 billion of orders for a €1.25 billion transaction at 190bp over.
While investor yield-hunger drove strong demand for bonds offering coupons around 2.625%, banks still have much work to do filling out their TLAC ratios at the lowest possible cost. New Basel regulations disqualify old-style amortizing tier-2 bonds with less than five years remaining to maturity to count towards these ratios. UniCredit was the latest big European bank to take the decision to exclude all such bonds from calculations of its total capital ratios when it announced 2014 results in February.
Illustrating just how keen the search now is for investors to support the new B3T2 market, some issuers are even looking at deals in foreign currency. While it’s a simple matter for European banks to issue senior unsecured debt in foreign currency and swap funding back into euros, it’s much trickier to do this on bank capital issues, where the liability remains in the nominal currency of issue and so may open up a mis-match if not allocated against risk-weighted assets in the same currency.
Banks have begun testing the waters though. This year French bank BPCE became the second European bank to issue B3T2 subordinated debt denominated in yen in a three-tranche Samurai deal totalling ¥48.3 billion ($404 million), comprising ¥27.2 billion of 10-year fixed-rate bonds priced at 154bp over en swaps; ¥7.9 billion of 10-year non-call fives at 169bp over swaps, and a 10-year floating-rate note.
BPCE follows Rabobank, which became the first issuer in the Samurai market for B3T2 with a ¥50.8 billion 10-year bullet last December.
It was tough work to get both deals up to benchmark size, which in the Samurai market is considered to be around ¥50 billion, while still achieving pricing in line with euro and dollar subordinated markets for these issuers.
“Japanese investors tend to be very conservative and highly selective on credit risk, especially among foreign issuers,” says Marc Tempelman, co-head of debt capital markets and corporate banking, EMEA, at Bank of America Merrill Lynch, which led both deals. “But with JGBs offering next to nothing at five years and trending in a historical low range of 0.2% to 0.4% at 10 years, there was an opportunity to attract new institutional investors – including among Japanese life insurance companies, trust banks and others – that would never buy European banks euro-denominated B3T2 issues.”
Those Japanese investors have very good reason to be wary. There is an assumption that domestic Japanese banks’ subordinated tier-2 deals would enjoy some protection under deposit rules and that Japanese law might allow the government to inject capital into failing banks.
By contrast, for European bank issuers, the assumption has to be that while the likelihood of bail-in of subordinated tier-2 is remote – because AT1 holders would be bailed in earlier on breach of regulatory capital triggers and regulators would press for emergency rights issues – if losses were ever imposed on B3T2 holders at the point of non-viability, then investors are quite likely to face a total wipeout.
European bank issuers in samurai
Both Rabobank and the lower-rated BPCE have been frequent issuers of senior unsecured debt in the Samurai market over the past five years, giving them a headstart to develop an investor base for subordinated debt. Even Rabobank needed to do a lot of work to persuade some of its investor-following to stretch into capital instruments.
“Japanese investors cannot imagine a big domestic bank failing,” says Tempelman, “but before taking such risk on a foreign bank, investors wanted to see the white of senior managements’ eyes in pre-deal soft-sounding, even before official roadshows began.”
It’s not clear how sophisticated the questions were from these investors. Gen Sakai, head of Japan debt syndicate at Bank of America Merrill Lynch in Tokyo, says: “While some investors look at absolute yield relative to JGBS – and investors held out for a 2% coupon on the 10-year fixed-rate tranche for BPCE, for example – some Japanese investors wanted to refer to euro- or dollar-denominated secondary levels in order to assess the fair value in yen.” They wanted to make sure they weren’t getting a worse price than BPCE’s home market investors.
Rabobank was pleased with its deal. “The pricing was carefully set to reflect Rabobank’s tier-2 secondary curves in euros and dollars,” the issuer stressed.
It’s revealing that BPCE, whose subordinated bonds are rated at A- by Fitch, compared to A+ for Rabobank, still got a successful deal away even amid the bond market volatility in the run up to the announcement of quantitative easing and the Greek bailout extension.
Bankers suggest that with a new Japanese financial year starting in April, investors sitting on cash will be eager to put that to work in yielding instruments.
“The Japanese investor base for these deals will expand after the more sophisticated and flexible investors that supported the Rabo and BPCE deals have pioneered the way,” Sakai suggests. “But this will likely remain a market open only to better-rated banks from better-rated countries and to those already well-known to Japanese buyers in the senior unsecured market.”