Subordinated debt is growing fast in France. Investors are
seeking yield enhancement at a time of low interest rates and the
country's banks and insurance companies are trying to bolster their
capital ratios without increasing their equity base.
A growing range of tier one and tier two products have been readily
absorbed in the French market over the last year. But, for many
French financial institutions, the US market remains the key
capital-raising focus offering a breadth of products and a deep
investor base that their domestic market cannot match - at least
French investors' sudden desire to increase their investments in
spread product, a trend sparked by the decline in interest rates
last year, could not have come at a better time for the country's
banks. Many of them are undercapitalised and desperately need to
lift BIS ratios that have been depressed by loan write-offs in Asia
and at home.
At the same time, the banks are struggling to lift their miserable return on equity figures while French equity investors are becoming increasingly intolerant of rights issues unless the company has a good story to tell - all of which makes non-dilutive sources of capital like subordinated debt much more attractive.
Meanwhile, investors are overcoming their previous aversion to subordination, acknowledging the product as just another security that offers more yield in return for greater risk. "There is massive demand for subordinated debt," says Nicolas Pourcelet, head of capital markets at Lehman Brothers in Paris.
This was evident last year when Banque Nationale de Paris launched a Ffr1.25bn step-up perpetual to a rapturous reception for investors. The demand from French investors was so strong in 1997 that several foreign banks launched subordinated deals in the currency: Chase brought a Ffr1.2bn 12 year issue with a 6.125% coupon in September 1997, which it increased by Ffr500m this March, while Credit Suisse First Boston followed BNP's lead to issue a Ffr1.25bn step-up perpetual.
French investors' increasing comfort with the idea of subordination was evidenced in late March when CDC Marchés brought a Ffr1bn subordinated issue for Bankgesellschaft Berlin linked to the Tec 10 rate. The buyers were insurance companies interested in the Tec 10 link for asset liability purposes - subordination was virtually irrelevant to them.
The French market has attracted foreign issuers in increasing numbers because it is so open to new structures. Barclays Bank, for instance, experimented in early March by launching Ffr1bn of lower tier two capital through a five non call 10 structure.
The issue pays a fixed rate of 4.875% for the first five years stepping up to 82.5bp over Pibor after the call option. The success of the deal also demonstrated that the universe of French investors for dated subordinated debt is much greater than for perpetuals with a call option.
Perhaps the most unusual deal of the past 12 months came from French insurance company Axa, which brought a two tranche step-up perpetual in November 1997.
Merrill Lynch was global co-ordinator with Goldman Sachs, Paribas and Chase acting as joint leads. The transaction comprised a $400m tranche paying 60bp over Libor until its call option at 10 years, after which the spread steps up to 210bp over Libor. There was also a Ffr3.8bn tranche with the same 60bp spread over Pibor, also stepping up to 210bp over after a 10 year call.
At the equivalent of $1.05bn, this was one of the largest perpetuals ever and is one of the biggest subordinated deals in the international markets for an insurance firm, which have been rare issuers of this type of debt.
The deal was a success - much to the surprise of some bankers since it was launched when the Asian crisis had all but closed down the international bond markets.
Axa's motives for doing the deal were less clear-cut than in the case of the banks. About half the proceeds were used to refinance senior debt while the remainder was injected into start-up companies. The bonds were issued by its holding company, which faces no explicit capital constraint, so there is no immediate regulatory benefit.
"It was a good opportunity to raise new capital, taking into account the low level of interest rates," says Virginie Cayatte at Axa's financial and treasury department. "It worked out cheaper than issuing shares, since our goal is to achieve a 15% return on equity."
She adds: "The subordinated issue would be classed as capital by insurance regulators if the holding company was consolidated with our insurance subsidiary, while the rating agencies will treat this as capital immediately."
The two tranche structure demonstrated another attractive feature of the subordinated market. It allowed Axa to raise over $1bn at a level of pricing that would probably have been unachievable in any one currency. It also offered dollar denominated capital while the equity market is still ineluctably linked to the French franc.
While issuance of French franc subordinated debt blossomed in 1997 and 1998, French banks have started looking further afield. BNP has led the way, launching a $350m 10 year Yankee in January 1997 via Salomon at a fixed rate of 7.2%.
It was followed in August that year by Société Générale with a controversial $800m issue via Goldman Sachs structured through a real estate investment trust (Reit) in Delaware.
That deal was devised to achieve what hitherto had been unachievable for European banks: combining the benefits of subordinated capital, notably the tax deductibility of interest payments, with recognition by
regulators as tier one capital.
However, the insurance companies that constituted the main buyers of the securities issued by the Reit were subsequently required to class them as equity, not debt, which makes more such issues unlikely.
Nevertheless, the US market remains interesting to French banks given the depth of demand for subordinated debt and equity hybrids.
Natexis Banque, for instance, is readying an issue of fixed rate preferred stock in the US through which it hopes to raise $250m of capital.
Its BIS ratio slipped to 8.5% at the end of 1997 and this issue will help lift it to around 9%. "Our aim is to achieve 6% tier one capital," says Olivier Schatz, chief financial officer at Natexis Banque.
However, the bank is under pressure to lift the return on its equity, which rose last year but only to 3% - hence its interest in a non-dilutive source of capital like preferred stock.
With demand in Europe for subordinated issuance sapped over the past 12 months through heavy issuance by Japanese banks, many more French banks may follow Natexis' lead. EW