UBS to issue more loss-absorbing capital

(Reuters/IFR) - UBS might struggle to attract big institutional investors for more loss-absorbing bonds it wants to sell, after investors voiced distaste for the structure and price of an initial US$2bn deal announced on Wednesday.

UBS’s new bonds are designed to help bolster the bank in tough times by absorbing losses. Their value can be written down if the bank’s common equity Tier 1 ratio – a measure of financial strength – falls below 5% or hits non-viability.

The bank, which needs to raise a total of roughly US$16bn to meet new capital rules, said on Wednesday it is weighing issues in other regions and currencies which are likely to exceed US$1bn in size.

UBS attracted US$5.5bn of demand from investors, which UBS said included private banks – which traditionally means wealthy clients – long-only asset managers, hedge funds and banks investing for their own portfolios, in Asia and Europe.

But they also drew sharp criticism from several potential institutional buyers, who said similar issues from UBS and other banks will be a tough sell.

The UBS issue is a closely-watched gauge of investor demand for subordinated deals with permanent write-down features as banks brace for tougher requirements on bank capital instruments.

“It’s clearly not an investor-friendly structure, there are lots of embedded options by the issuer and the regulator, and one is the non-viability option,” said Philippe Kellerhals, senior portfolio manager at London-based Cairn, an asset management and advisory firm.

“Another is the Basel III capital trigger: when that happens, investors in these notes get completely wiped out.”

Ratings agency Standard & Poor’s estimates banks will have to raise about US$1trn in capital to replace old hybrid instruments which no longer qualify as loss-absorbing under the Basel III reforms aimed at making banks more crisis-proof.

Strong capital

Fixed-income specialists also criticised the pricing on the UBS bonds, which offer lower yield than senior notes currently on offer from Dutch cooperative Rabobank.

UBS maintained that is is happy with the issue’s reception, and that investors are “comforted” by the bank’s Tier 1 capital ratio of 14.1% under Basel 2.5, compared with the 5% trigger.

“The very competitive coupon of 7.25% for this 10-year benchmark size offering reflects UBS’s strong capital, liquidity, and funding position,” UBS’s financial head Tom Naratil said. UBS’s capital ratios are among the strongest of European banks.

The UBS issue comes one year after Credit Suisse issued SFr6bn (US$6.6bn) in so-called contingent convertible bonds, or CoCos, to existing shareholders and a further US$2bn of CoCos publicly. These bonds aim to absorb losses by converting to equity under certain conditions.

These new types of loss-absorbing bonds are a response to tough capital rules laid out by Swiss financial regulator FINMA after the financial crisis.

Unlike Credit Suisse’s bonds, UBS’s will not convert to shares if the trigger is hit, reflecting the bank’s desire not to dilute shareholders following repeated cash calls as it struggled under the weight of more than US$50bn in mortgage-writedowns during the subprime crisis.

UBS’s 10-year notes sold last week would trigger at a 5% common equity ratio.

That means the bonds would be written down permanently if the bank’s common equity Tier 1 ratio falls below 5% or if the bank is considered non-viable.

The Swiss regulator can trigger non-viability if it sees an impending collapse or bankruptcy of the bank.

Ratings agency Fitch assigned the notes a BBB– rating.

During the financial crisis, UBS accepted a government-backed rescue package in October 2008. Credit Suisse did not take state aid and raised capital privately.

(Reporting by Katharina Bart of Reuters in Zurich; Additional reporting by Helene Durand of IFR in London)

(US$1 = 0.9107 SFr)