Leap of faith: UBS made a bet in August that US desperation for yield was at fever pitch, and won in style when it launched the first ever Yankee CoCo deal. The US$2bn Tier 2 write-down transaction’s stellar performance since then has opened the market for others to follow, making it IFR’s Financial Bond of the Year.
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Buying European senior unsecured debt seemed a big enough gamble for US investors for much of 2012, so it was a significant leap of faith when UBS asked them to buy a deal in which they risked losing all principal if the bank’s Tier 1 common equity capital breaches a 5% threshold. No one had tested US appetite for such an aggressive structure, and few thought it possible.
“This deal is toxic,” said one DCM head away from the trade before pricing. “Permanent write-downs are just a very difficult structure to do. Convertible into equity, yes. But write-downs? No.”
Yet UBS’s subordinated Tier 2 write-down transaction not only attracted US$9bn of orders from more than 450 investors, but has since soared in price, enabling Barclays to follow up in November with an even more aggressively structured transaction in which the notes will be automatically written down to zero if Barclays’ Common Equity Tier 1 ratio falls below 7% (post-CRD4).
“The UBS deal traded better than anyone thought it would,” said one banker when explaining why the Barclays trade was able to attract a US$17bn book. “It [the UBS deal] has gone up to US$110, which has prompted the market to take a good hard look at the product.”
At the time of pricing, there was no reason to think that US investors would ever consider buying a bond that posed the risk of writing down principal, let alone one from a European bank.
But when they saw the 8% whispered level on the UBS deal, investors responded with a resounding yes.
Orders grew to about US$6bn on the day it was announced in New York, and attracted another US$3bn overnight.
With a US$9bn global book, managers UBS (global co-ordinator), Bank of America Merrill Lynch, Citigroup, Goldman Sachs, JP Morgan, Morgan Stanley, Royal Bank of Scotland and Wells Fargo Securities, were able to tighten pricing in to 7.625%.
It was a yield that no one could dream of getting from capital securities issued by US banks and insurers.
That point was driven home a week before the UBS deal when Wells Fargo issued a retail-targeted US$675m perpetual non-call five-year Tier 1 preferred at 5.2%, at the time a record low for the structure.
Investors were even being offered Tier 1 capital securities by US financials more than 100bp inside of what UBS was offering. In late July, for instance, GECC set a low coupon record for pure institutional Tier 1 at 6.25%.
The deal proved that European banks need not rely only on private Asian accounts to buy their US dollar-denominated Tier 2 CoCos, which some had done through Reg S.
The offering ended up being allocated primarily to US accounts, who bought 58% and Europeans, who bought 34%. The remainder went to Asia.
The book had a good mix of investor type, with 49% going to fund managers, 23% to private wealth investors, 10% to hedge funds, 6% to banks, 4% to insurance companies, 2% to corporates and another 6% to other buyers.
With both the UBS and Barclays CoCos in the market, the hope is that a foundation has been laid for the product in the US, at least for Yankee issuers.
Swiss banks have to issue CoCos because under the so-called Swiss finish – the country’s large banks must have a 19% total capital ratio by 2019, divided into 10% of Common Equity Tier 1 capital, 3% of high-trigger contingent capital and 6% of low-trigger contingent capital.
Barclays’ US$3bn 7.625% 10-year CoCo gives bankers hope that others will follow suit once the structure is given formal global regulatory endorsement.