Deals of the Year 2008: A year of living on the edge


Alex Chambers
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The most canny issuers in 2008 were those that realized it was important to get on and raise capital even if the price was not great. Waiting for the market to improve was and remains a potentially fatal strategy. Alex Chambers reports.

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CAPITAL-RAISING MATTERED more than ever in 2008. There seems little doubt that it will also be a big theme during the next 12 months.

Last year was dire for the capital markets. Right from the off, activity was subdued, even in the US where the primary market normally has a roaring start to the year. The tensions that began in 2007, when concerns about sub-prime related losses hurt investor confidence in the investment banking community, became so great in 2008 that they cost many institutions their independence or even existence.

"The overriding theme of last year was the wisdom of taking the money when it was there," says David Marks, chairman of FIG DCM at JPMorgan.

Having spent much of 2007 holding to the belief that it was possible to sit out the crisis, in the course of 2008 many borrowers began to take on board the fact that waiting for better times was a risky option.

This is why last year timing and structure mattered to a far greater degree than is normally the case. Mess up the strategy, or even worse fail to execute a deal, and the fate for management could be worse than just embarrassment.

But in a year with few positives, one message stood out: smart issuers and savvy advisers showed that capital could be raised in many markets, no matter how bad the background story.

"No one that did a deal in 2008 regretted it subsequently," says Marks. "The banks that came through the year perceived as having weathered the storm basically did that."

"No one that did a deal in 2008 regretted it subsequently. The banks that came through the year perceived as having weathered the storm basically did that"

David Marks, JPMorgan

David Marks, JPMorgan
The year was bookended by two massive allegations of financial fraud. The first centred on French bank Société Générale and one of its equity derivative traders, Jérôme Kerviel – the last was the alleged Ponzi scheme masquerading as the hedge fund run by Bernie Madoff. Both had big implications for the capital markets. The alternative investment – particularly funds of funds – industry has been left in turmoil by the failure of so many institutions’ risk-management processes. And the multi-billion euro loss at SG left the bank weakened, and not just financially.

Details of the primary reason for Société Générale’s emergency equity capital-raising needs no retelling here, such was the breadth and depth of media coverage of the equity derivative trading loss.

But while the fraud’s implications for risk management in banks is fully understood – what has been overlooked is how SG managed to avoid complete disaster by taking swift remedial action in an emergency capital-raising fully underwritten by co-bookrunners JPMorgan and Morgan Stanley.

This deal mattered because it showed that there was capital available to financial institutions – even under circumstances as unfavourable as SG’s, and against such a negative backdrop.

The most important aspect for SG was that it was able to announce to the market the cure at the same time as unveiling its ailment. This was important, given the scale of the losses and the tangible dent in investor confidence. The recapitalization took place at the start of the year – giving SG first-mover advantage in the vibrant capital-raising theatre for financials.

Investors were afforded the opportunity to participate in the rights issue – thus avoiding significant dilution. The offering was one new share for four existing, with the new capital ineligible for the 2007 dividend.

Price action in the stock market indicated a positive investor response – during the subscription period SG’s stock rose 6.6% while the CAC40 lost 0.5%. And there was no discrepancy between where the rights issue traded and the theoretical ex-rights price, so shareholders were able to make a straightforward choice between subscribing or selling their rights. As it was, the issue was 1.8 times subscribed.

Wisely, the bank raised enough capital to cover losses linked to credit positions additional to those caused by the rogue trading and its concealment. So in addition to the €4.9 billion earmarked for the trading loss, capital was raised for write-downs in relation to US residential mortgage risk and exposure to monoline insurers, coming to €1.1 billion and $900 million respectively.

Lesson not lost

The benefit of being one of the first in the queue had not been lost on other banks. Just before the SG rights issue was unveiled, Bank of America was out of the blocks with a jumbo preferred securities deal that neatly straddled both retail and institutional buyers.

Historically, US banks issued non-cumulative preferred stock to a small specialized investor base that valued the dividends received deduction (DRD) tax benefit that the holders of preferred stock receive.

The US retail preferred market has substantial size constraints. A multi-billion dollar offering would clearly require institutional participation. Usually retail-targeted deals would not exceed $1 billion – for years the largest had been a $1.25 billion transaction for ABN Amro.

The problem was that there were structural nuances that these investors liked that ruled out most institutional investors. Of these, Bank of America recognized those structural aspects that could be changed to bring in additional investors with deep pockets.

Changing the payment terms from quarterly to semi-annual enabled BofA to access mainstream institutional investors – no bad thing given that the DRD investor base is relatively limited. The bank’s use of a traditional, retail, non-call, five-year structure alongside a $1,000 par coupon, dropping the $25 par format – and ensuring that trading of the security took place with accrued interest, as opposed to clean – was essential to its success. Bank of America also dropped the traditional preferred Cusip for a debt securities identifier.

Investors and regulators are increasingly turning their backs on the complex structures of the past. The relatively simple structure utilized by Bank of America to such powerful effect was mirrored by other US banks to draw down substantial amounts of capital from the preferred market. Such capital-raising was essential for the significant balance sheet repair needed without diluting common equity holders. Wachovia issued $3.5 billion in February, and JPMorgan and Citigroup each issued $6 billion in April. Some $26 billion of the $29 billion of institutionally placed DRD preferred securities have used the BofA structure.

If these capital raisings were important for the individual institutions concerned, the UK government’s decision to boost the capital of key domestic banks had far wider implications.

The recapitalization of the UK banking system was crucial. In many eyes, financial Armageddon was approaching fast. The then US administration’s idea of dealing with solvency issues by buying banks’ bad assets was floundering.

After central banks around the world spent months arguably addressing the symptoms of sub-prime related losses – the financing and liquidity crises – finally here was an attempt by a government to deal with banking solvency efficiently. The action taken was unprecedented but completely necessary considering how bad the financial world looked in early October: Lehman Brothers had defaulted, while Freddie, Fannie and AIG were placed under US government control. Ahead of the IMF/World Bank meetings in Washington it really seemed as if the entire global financial system was ready to crash.

Credit Suisse and Deutsche Bank acted as advisers on the UK government-supported recapitalization scheme that was announced on October 8 2008. The capital investments were in the form of both ordinary and preference shares (the latter have since been converted into ordinary shares in the second bail-out arranged in January). Royal Bank of Scotland was injected with £15 billion of ordinary shares, £5 billion of prefs. Lloyds took £4.5 billion common and £1 billion prefs and HBOS required £8.5 billion and £3 billion respectively.

This capital requirement was decided upon in a short time and included structural analyses, regulatory capital/stress testing and a management session on the equity story, trading book and asset values.

It is said that imitation is the sincerest form of flattery – and indeed the UK government’s formula was largely replicated around Europe and in the US. The fact that secondary action was required in mid-January 2009 should not detract from the merits of the initial action. Few at the time thought that raising the banks’ tier 1 capital ratio to 9% would be inadequate. There is no doubt that the imminent collapse of the UK banking system was averted.

The UK was quick to follow up on its capital injections with a financing scheme for its financial institutions. But it was the establishment of the Société de Financement de l’Economie Française (SFEF) agency in 2008 in France that was the best solution to the funding crisis that banks find themselves in.

SFEF is a pass-through vehicle, two-thirds of which is owned by seven large French banks – BNP Paribas, Crédit Agricole, Société Générale, Groupe Caisse d’Epargne, Banque Fédérative du Crédit Mutuel, Groupe Banque Populaire and HSBC France. The remainder is held by the French state. The state in fact provided its explicit, irrevocable and unconditional guarantee to SFEF debt (which is limited to five years at most).

This government-guaranteed debt sector has had a remarkable impact. It was an asset class established virtually overnight and investors were unbelievably responsive to its appearance. Spreads on the supranational and agencies’ key names ballooned out by 60 basis points, in some cases, from swaps less 40bp to plus 20bp, in a matter of days.

BNP Paribas, Calyon, HSBC, Natixis and SG CIB were the lead managers on the inaugural €5 billion three-year bond.

Paul Hearn, BNP Paribas

"In terms of the way to approach the market, SFEF has probably done it best. Other governments have probably come to realise that they would have been better off with a single name"

Paul Hearn, BNP Paribas

"In terms of the way to approach the market, SFEF has probably done it best. Other governments have probably come to realise that they would have been better off with a single name," says Paul Hearn, co-head of origination and distribution at BNP Paribas at the time of the deal.

He adds: "SFEF borrowers issued at a tighter spread than all the other government-guaranteed names." Why is it that SFEF is enjoying a 10bp to 20bp cost saving? The fact is that a greater number of investors are able to participate in a SFEF deal because they only have to conduct the credit due diligence once. The result was that SFEF was able to attract substantial amounts of central bank and other non-French investor cash.


The focus of the primary markets was firmly on the nature and impact of government aid during this period. If it was not pondering the implications of the billions of capital injected to bolster banks’ balance sheets, it was wondering who the winners and losers of the credit guarantees would be. The urgent nature of the action highlighted how bad things had got – but for there to be an endgame, the funding and capital provided must lead to a restoration of normality.

Lloyds TSB’s £400 million senior unsecured, unguaranteed offering surprised observers – especially as it came at the same time as the very first UK guaranteed deal, for Barclays Bank.

"Amid the worst possible headlines post-Lehman’s [default], Lloyds came out with a well-priced landmark transaction," says Paul Johnson, head of debt capital markets, Europe, at RBC CM. RBC was lead manager alongside UBS and Lloyds TSB itself.

It was the first public syndicated bank issue since the markets closed in September 2008 and after the Lehman Brothers default. It was also the bank’s debut European senior bond and followed quickly in the wake of the capital-raising that took place in October.

It took advantage of the underlying bid to the market. Johnson says that the credit curve at the time of Lloyds’ issue was very flat so that the cost of extending out to the 10-year was far from penal. In the new world order of substantial government supply and guaranteed short-dated issues, it was a surprise to many that there was demand for a deal at gilts plus 225bp. The issue was driven by a lead order uncovered by the leads. It suggested that there was light at the end of the very dark tunnel that borrowers have found themselves in.

A stiff drink

The $62 billion acquisition financing of Anheuser-Busch by InBev was the largest all-cash deal ever and was the biggest M&A deal of the year. It involved the largest-ever rights issue in the consumer sector and was the largest corporate rights issue in 2008.

Perhaps more important than all of these claims to glory, it signalled the end of an era. It was a testament to the strength of the relationships the core bank group has with the borrower and to its nifty syndication of the $45 billion loan that its members are not still wearing substantial amounts of the deal. The group was initially Santander, Barclays Capital, BNP Paribas, Deutsche, Fortis, ING, JPMorgan and RBS, later joined by Mizuho and Tokyo-Mitsubishi.

"At first there were a lot of rumours that a deal of this size could not be achieved," says Vincent van Liere of ING’s loan syndication desk.

Van Liere explains that the syndication process in September was shortened amid tight market conditions. The pricing and, more important, the size of this deal were from another era, but by establishing clear take-out opportunities, with roles for the participating institutions, the syndication was ultimately successful – without a reverse flex (an unusual situation where spreads on a syndicate loan are widening). The loan was structured into two one-year bridge facilities of $12 billion and $7 billion, and two $13 billion term loans – of three years and five years. The one-year tranche paid Euribor plus 100bp, the three-year 137.5bp and the five-year 175bp. It’s hardly in line with where most banks fund these days but the ancillary opportunities made the business worthwhile. There is no doubt that it represents the high-water mark for investment-grade, debt-financed buy-outs. A five-year term would be out of the question at the moment; even a three-year is challenging.

Underwriters also committed themselves to a $9.8 billion standby equity facility for four months, providing InBev with certainty of equity financing ahead of the rights issue. At the same time it decoupled the rights issue from the initial capital-raising announcement. There was an upfront bookbuild of ex-rights shares to allow the smooth sale of rights not taken up by existing shareholders.

Another era

E.On sold a benchmark transaction that was, again, almost from another era. It took place in early May 2008 when the market was red hot. Despite overall debt falling by 27% during 2008 year on year, numbers for the first half of the year were actually very strong – in terms of supply. Much of the deterioration took place in the second quarter – following the US government sponsored takeover of Bear Stearns by JPMorgan.

E.On wisely took advantage of euphoric markets, printing €2.5 billion of five-year and 12-year paper at mid-swaps plus 73bp and 110bp. So what made this a deal that truly mattered? Calyon, Commerzbank and UniCredit were the bookrunners on the deal, whose spreads might have seemed juicy at the time but were in truth a bargain for the borrower – even one as stable as this stable, single-A-rated utility.

E.On was swift to take advantage of the vastly improved conditions. It pushed the boundaries in terms of tenor, being the first corporate – outside of triple-A-rated – to issue a 12-year or longer bond. It was a textbook transaction with a heavily oversubscribed order book allowing the leads to execute the five-year inside the indicative spread (75bp to 80bp) on the five-year and at the tight end of the range for the 12-year. The good times were not to last, however.

"The market really changed last year. There were long periods where it was completely closed, and that hasn’t happened for a long time," says Chris Tuffey, head of EEMEA debt capital markets at Credit Suisse. It was after one of those virtual shutdowns that IBM reopened the US debt capital market with some aplomb. It had been weeks since any corporate, other than a utility, had tested the depth of investors’ appetite. IBM used the backdrop of strong third-quarter earnings announced on October 8 to launch a deal via Bank of America, Barclays Capital, Credit Suisse and Deutsche Bank. The $3 billion minimum target size was far greater than the sub-$1 billion-sized issues that had prevailed in the preceding weeks.

Borrower and investors kept their nerve against a negative backdrop. Attracting a $6 billion order book in the face of the Dow Jones Industrial Average tumbling 650 points was remarkable but then so were the spreads on offer. The five- and 10-year bonds offered 387.5bp over treasuries, while the 30-year offered 400bp. But despite these eye-popping spreads, the coupons were 6.5%, 7.625% and 8% respectively.

The $4 billion deal was the largest corporate offering since June and paved the way for a flurry of bonds that were based on the premise that it was better to pay the price to get liquidity than wait for the optimal moment. Pepsi Bottling Group, PepsiCo, Coca-Cola Enterprises, Verizon Communications and Altria all came to the market with large deals in the three weeks after IBM.

The deals of 2008 showed that corporates no longer assume that the financial crisis is just for banks to worry about. When several big counterparties go down, it’s time to wake up and establish strategies to avoid the worst.

"The liquidity discussion is no longer being held at solely treasury level but at a CEO level. It is a significant and strategic topic for boards of many European corporates," says Stephen Jones, head of the European financing solutions group at Barclays Capital.

This year’s amazingly bullish start is a reflection of that. Those that have access are taking full advantage. But there are plenty still unable to do so.

"I think there will be good businesses that fail this year not because of solvency but for liquidity reasons. And that is the thing I’m most concerned about. We will work hard to prevent this from happening where we are able to influence the outcome," says Jones.