Americas Structured Equity House

IFR Review of the Year 2012
9 min read
Stephen Lacey

Dressing to the left: When both straight debt and convertible bond markets were open to issuers, equity-linked lost out. Expertise in structuring deals and an ability to drive their economics were key in convincing issuers to step up to meet investor demand. Credit Suisse is IFR’s Americas Structured Equity House of the Year.

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Corporations that had the flexibility to choose a funding route almost universally opted for straight debt over any equity-linked solution in 2012. Enticed by low interest rates and tightening credit spreads, there was little need to expose shareholders to the risk of dilution.

“I think people were surprised by the light volumes that we’ve seen this year as well as over the past three years,” said Steven Winnert, head of equity-linked origination for the Americas at Credit Suisse. “But I also think most people believed interest rates would not have stayed this low for this long.”

In 2012, convertible bond issuance plunged to US$19.1bn, down from US$30.8bn last year and continuing a trend that has seen volumes fall to decade-low levels. With a few exceptions, investment banks responded by cutting or reallocating resources previously devoted to the asset class.

Credit Suisse was one of the few banks that actually added to its group, nabbing Will Brett in July 2012 from Nomura to augment its equity derivatives practice, which falls under Winnert.

Along with Winnert and Tobias Schraven, the addition of Brett gave the bank three managing directors in its Americas equity-linked practice and builds out capabilities across call spreads, structured share repurchases, margin lending, and monetisation of cross-holdings.

Shifting focus

The core convertible bond business suffered from a lack of corporate interest, placing greater emphasis on banking and structural advice to ensure seniority in deals won from lending relationships.

Credit Suisse ranked a distant sixth in the US structured equity league tables with US$1.5bn across 12 deals over the consideration period when equal credit is apportioned among joint bookrunners, despite acting as a lead loan arranger for two of the issuing clients.

JP Morgan, by comparison, ranked first with US$3.4bn of business on 27 transactions, of which it was lead loan on five situations, according to Thomson Reuters data.

However, when credit is awarded entirely to the lead-left bookrunner, Credit Suisse climbs to the top of the league table, with US$3.3bn of business across seven of the transactions. JP Morgan (US$3bn, 11 deals) falls to second on this same measure. Bank of America Merrill Lynch saw the steepest decline, falling from second (US$3.1bn, 19) to fifth (US$1.9bn, six), by IFR’s numbers.

“When I get hired for a deal of any significance, I’m usually on the left,” said Winnert. “I’m getting hired for the ideas and solutions I am providing, not because I’m lending.”

The way forward

WellPoint, rated Baa1/BBB+, and its decision to issue a US$1.5bn, 30-year CB in October is emblematic of the stigma many companies faced when issuing a convertible bond. Having just raised US$3.25bn from the four-part sale of straight debt to help fund the acquisition of rival Amerigroup (for US$4.9bn), the healthcare insurer certainly had its choice of financing options.

“We had been looking at convertibles, specifically this convertible, for a number of years,” said Merrill Yarling, staff vice-president of capital markets at WellPoint. “You have to understand that this isn’t the cheapest source of capital. When you’re able to issue senior debt at 4% it’s pretty hard not to do so.”

Credit Suisse, which was lead-left on the CB, was there throughout, advising the company on a series of acquisitions and championing a long-dated CB as a cost-efficient way to balance the needs of debt and equity holders, while providing the benefits of tapping a new constituency of CB investors.

The concurrent repurchase of US$400m of stock on the CB placement reinforced the company’s commitment to shareholders and was consistent with a targeted return of US$3bn in 2012 from dividends and buybacks. Bifurcation of the security into its debt and equity components put US$500m of equity on to the balance sheet, reducing leverage to below 40% in terms of debt to capitalisation and working towards a 30%–35% target within 18 months.

The security also provided tax efficiencies. Because of contingent interest provisions, a series of payments made to investors as an inducement not to convert, the ultimate value of the payout to investors is not known. Instead of deducting interest expenses at the 2.75% cash coupon on the CB, WellPoint is allowed to deduct at the higher, 5.13% rate it would pay on equivalent straight debt, shielding roughly US$25m of earnings annually from taxes.

More impressive was the overwhelming investor demand for the security from CB investors. After a one-day marketing period that generated a 100% hit rate from one-on-one meetings, investor interest swelled to 4.5 times the targeted size, allowing for pricing at a 2.75% coupon and 25% conversion premium, the upper-half of 2.5%–3% and 25%–30% price talk.

“Even though the straight debt markets are at 11 on a scale of one to 10, the convertible market may be a 12,” said Yarling. “The market has been so undersupplied I thought that the dynamics would allow us to achieve a favourable outcome.”

Built to fit

Even in situations where Credit Suisse was not awarded lead-left bookrunner and did not have a direct lending relationship, the bank made a difference through advising on structuring and capital structure. A prime example was real estate firm Hovnanian Enterprises and its desire to lower borrowing costs and extend maturities with a two-part US$900m offering of secured high-yield and unsecured convertible debt is a prime example.

Having been given a choice of which financing to lead, Credit Suisse chose the more lucrative high-yield placement, leaving the lead-left role on the CB to JP Morgan, a key lender. The appointments reflected key structuring advice provided by Credit Suisse.

The challenge stemmed from bond indentures that limited the amount of senior debt that could be issued as well as any cash payments on any subordinated securities. Although it would cost US$900m to tender for US$797m of existing debt, after factoring in fees and call premiums, Hovnanian could only issue US$797m of new secured debt.

“The covenants didn’t allow us to increase secured indebtedness to cover frictional costs associated with the tender,” said Hovnanian CFO Larry Sorsby. “We could have used cash but we didn’t want to use up precious liquidity.”

The workaround resulted in more innovative CB financings in 2012. To get around senior indentures, Credit Suisse recommended a CB structured as a unit of an amortising note and unsecured zero-coupon bond to replicate the payout profile of a traditional CB.

Final pricing of the five-year CB at a 6% coupon and 40% conversion premium found widespread appeal among outright and yield-oriented investors seeking to participate in the still-budding housing recovery. Highlighting the outright orientation, Hovnanian shares traded up 1.6% over the one-day marketing period.

The recovering housing market was a significant theme in the capital markets, and convertible bonds proved attractive as growth capital. Credit Suisse made its presence evident on structured equity offerings for homebuilders Beazer Homes and Standard Pacific in July, and through the introduction of mortgage-servicing rights provider Walter Investment Management.

Like Hovnanian, Walter Investment pushed the thresholds of its capital structure on the concurrent sale of stock and convertible bonds that raised a combined US$517m in October, more than one-third of its market capitalisation at the time. The threshold in this case stemmed from a US$265m second-lien term loan whose indentures required repayment on a debt funding and limited the size of the funding to the size of the loan.

That size restriction helped to achieve aggressive-end pricing of 4.5%, up 40% on the seven-year CB, and providing flexibility to increase sizing of the common stock placement from 4.5m shares to 6m shares. Furthermore, a two-day marketing period designed to educate investors on the still-emerging industry culminated in a 2.3% rise in the issuer’s share price, despite the large relative size of the financing.

Credit Suisse acted as lead-left manager on both the equity and CB.

Dressing to the left