here are at least three reasons why borrowers across a range of credit profiles are making more of an effort to cultivate the Swiss retail investor base via the Swiss franc market than ever before. The first is that unlike the retail investor communities of most European economies, Switzerlands formidable base of wealthy private investors continues to expand.
According to the latest Merrill Lynch/Capgemini World Wealth Report, Switzerland is the eighth largest market in the world for high net worth individuals (HNWIs). More importantly, it is the fastest growing market in Europe. While the market grew by 7.2% and 3.4%, respectively, in Germany and France in 2010, and contracted by 4.7% in Italy, the Swiss HNWI market expanded by 9.7%.
Bankers say that in spite of some of the pressures being exerted on private banks since the signing of a number of agreements on tax avoidance, inflows into the Swiss private banks remain robust. Supported by a wall of money from wealthy individuals in emerging markets, Pictet, Julius Baer, Vontobel and Lombard Odier reported new inflows in 2011 of Sfr15bn, Sfr10bn, Sfr8.2bn and Sfr7.2bn. The much smaller Valartis, meanwhile, saw a quadrupling of inflows last year.
"Switzerland is still seen very much as a safe haven, which is why the private banks continue to see very strong inflows," says Heinrich Rohrer, managing director of Swiss trading and sales at Credit Suisse. "This is allowing them to launch a wide range of new high yield, emerging market and money market funds."
Profitability, however, remains under pressure throughout the Swiss private banking industry. "Running hard to stand still," was how UBS described the dilemma facing the Swiss private banks in a recent update. This warns, somewhat forebodingly, that "we see four key themes for the Swiss private banking sector in 2012: low net profit growth, focus on cost management, capital management, and ongoing pressure on Swiss banking secrecy."
Private bankers themselves confirm that these are tough times. "On an absolute basis things are very difficult in terms of profitability and margins," says Ulrich Bender, a director at Valartis Bank, which has about Sfr6.8bn of assets under management. "But on a relative basis our know-how, our legal system and the stability of our currency still makes Switzerland a good place to invest. As long as the eurozone crisis continues, we will continue to see healthy inflows looking for a safe haven."
The second reason for a growing range of issuers to intensify their focus on Swiss retail is that the private investor base shows little inclination to expand far beyond the perceived safety of the most conservative asset classes. Bender, for example, says that todays main trend in terms of private banks asset allocations is a preference for cash.
Stock crash nightmares
Even for those that are more adventurous, equities still appear to be regarded as too risky, even though the case for increasing equity allocations seems to be strengthening. "In the early months of the year many people expected private investors to shift to equities, given the rally we saw in the first quarter," says Manuel Bredol, who heads part of UBS fixed income sales in Zurich. "But we havent yet seen much in the way of switches from fixed income to
This, say bankers, is in spite of the very attractive yields offered by some of Switzerlands top companies. After all, why buy a Roche bond paying a 1% coupon when the shares yield 4.3% and trade on an undemanding multiple of 11.5 times projected 2012 earnings? Why look at 12 year Swisscom debentures with a coupon of 2.63% (which is where it priced an issue in August 2010) when its shares are yielding 6.1% and selling on a p/e multiple of 11?
Part of the answer, says Bredol, is that memories of previous stock market meltdowns remain all too fresh in the minds of Swiss retail investors. "Additionally, most of the names that pay high dividends are already core holdings for Swiss retail investors," he says. "Most Swiss private investors will already have stocks like Roche and Novartis in their portfolios."
The third and perhaps the most important reason borrowers have for focusing more intensively on the Swiss retail investor base is that in the last three years there has been a very marked shift in its investment strategy.
Local bankers say that it has been retail investors, through the private banks, rather than Switzerlands institutions, that have led the rise in demand for more diversification in the fixed income market. It is this demand that has opened the way for a series of lesser rated companies to tap the bond market.
"Private banks historically invested only in top quality bonds, but that was when interest rates were much higher and even triple-A bonds were yielding 2% or more," says Patrick Voegeli, head of fixed income at BNP Paribas in Zurich. "The big change came after 2008 when private banks were very disappointed by the poor returns they earned on hedge funds and other alternatives, and especially structured products."
Russia reveals trend
Voegeli points at retail investors demand for Russian issuers as perhaps the most compelling example of the trend.
"Weve led most of the Swiss franc deals for Russian borrowers since 2008," he says. "Some people assumed that retail demand for these issues had come mainly from Russian investors with private bank accounts in Switzerland. But while there has of course been some demand from Russian investors attracted by the credit, the main driver of demand has been Swiss retail, who are attracted by the coupon. They are comfortable with Russian credits, which have a good track record of repayment of their bonds, and they believe in the BRIC story."
Clear evidence of Swiss retail support for Russian borrowers this year came in February, when private banks led the Sfr325m 3-1/2 year bond led by Credit Suisse, Troika Dialog and UBS for Sberbank. Even though the coupon of 3.1% was the lowest ever from a Russian borrower in Swiss francs, the strength of retail demand allowed for the size of the transaction to be more than doubled from an originally planned Sfr150m.
Private bank clients have also been a key driver of demand for Swiss franc high yield issuance. "Issues for borrowers such as Sunrise, Swissport, Orange Switzerland and, most notably, Fiat have been underpinned mainly by retail demand and by asset managers running high yield funds," says Voegeli. Ninety percent of Fiats Sfr425m 3-1/2 year subordinated bond, led by UBS in February, went to retail investors and asset managers, who were drawn by the 5% coupon.
While this was seen as more than an ample trade-off for the credit risk associated with a southern European credit, much the same was true of the coupon offered by Iberdrola when it priced its first Swiss franc benchmark in January. This was a Sfr250m five year deal via BNP
Paribas and Credit Suisse, which
was also driven largely by retail demand, for whom the 3% coupon more than compensated for the Spanish risk.
Beyond emerging market, peripheral eurozone and corporate credits, bankers report that retail investors have been very strong supporters of bank hybrid debt in general and of contingent convertible (CoCo) securities in particular. "There has been extremely strong retail demand for CoCos," says Rohrer at Credit Suisse.
He says that private banks bought about a third of Credit Suisses inaugural dollar CoCo in February 2011, and that retail investors also provided anchor support for the Sfr750m 10 year non-call five buffer capital note launched in March 2012.
One very positive side-effect of the strength of retail demand for Credit Suisses debut Swiss franc CoCo, says Rohrer, has been its role in supporting liquidity. "If you have 150-200 private banks in the book distributing bonds to thousands of investors across their networks, you create a bid for small tickets which guarantees liquidity and generally supports spread tightening in the secondary market," he says.
Bankers say that in terms of maturities, retail investor demand continues to be concentrated chiefly at the shorter end of the curve. "If there is a ballpark maturity preference among retail investors it is probably for three years, which has been increasingly problematic in recent years," says Bredol at UBS. "The amount of performance that has been given up by retail investors has been quite significant for the simple reason that they have been too short in terms of duration."
The nexus of demand:6-1/2 years
A clear recent trend, however, has been the use of the intermediate 6-1/2 year maturity, which is viewed as the nexus of institutional and retail demand.
In early April, for example, two deals tapped the 6-1/2 year maturity within a week, with ASB Financial (Sfr200m) and Teva Pharmaceuticals (Sfr450m) both generating solid retail support.
But perhaps the most spectacular example of an issue tailored to maximise retail alongside institutional demand was Roches three-tranche Sfr1.5bn transaction via Credit
Suisse and UBS in February, which bankers say hit the spot precisely in terms of its maturity, name recognition and pricing.
"Domestic credits are especially well bid by private clients because of the name recognition," says Voegeli at BNP Paribas. "But 1% is the minimum acceptable coupon to retail investors. Below 1% probably would not have sold even for credit as popular as Roche."The importance of the retail investor in the Swiss franc sector, say bankers, makes the broader market quite unlike any other mainstream bond market. "The specificity of the retail investor base probably makes the Swiss franc market one of the riskiest in the world for lead banks," says Voegeli. "In many cases you need to take as much as 20% or 30% on your books, so youre hard underwriting without even sounding out clients. I dont know of any other market where banks are required to take similar risks."