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RSA and Rabobank write new chapter for subordinated debt

Nowhere was the resurgence of risk appetite among bond investors more clearly visible this week than in the subordinated financial institutions market where two issuers priced well received and heavily oversubscribed deals.

The new benchmarks gave market participants hope that investors were finally turning the page after a disastrous chapter of events in the asset class over recent months. That investors would even consider discussing the possibility of buying subordinated debt was seen as a great leap forward.

It will also give financial institutions across the globe a much needed boost as the transactions show that that there is perhaps private capital available in benchmark size for issuers — and not government money.

The fact that the transactions outperformed the market and tightened by 20bp-30bp post pricing should give the market a further boost.

"These deals show that investors will eventually start looking at perpetual securities again," said a FIG banker away from the deals.

"The subordinated securities that had been trading well below 50 are now back in the 70/80s as risk appetite returns and the large liability management exercises that have taken place take effect. It will be interesting as the market progresses to see whether investors will remember the past and price these securities adequately. What these deals show though is that the lower tier two securities still have integrity."

RSA Insurance Group priced a three-times covered £500m 30 year non call 10 via BNP Paribas, Deutsche Bank and Royal Bank of Scotland while Rabobank attracted over Eu2.6bn of orders for its Eu1bn 10 year bullet lower tier two via Bank of America Merrill Lynch, Barclays Capital and Rabobank.

While both transactions attracted nothing but praise from market participants, most agreed that the RSA issue was the one that stood out.

Indeed, not only does the deal have extension risk, the coupons are also deferrable and it was done in the sterling market.

The last time an issuer did a callable deal with deferral language in Europe was in January last year when Credit Agricole priced a sterling tier one transaction.

Meanwhile, lower tier two securities have traded at distressed levels across the board as issuers such as Deutsche Bank and Banco Sabadell declined to call their bonds, going against market conventions and investors’ expectations that the deals would be called at the first opportunity.

However, they have particularly suffered in the UK, where the government changed the language on the lower tier two securities issued by Bradford & Bingley, following its rescue of the bank last year.

"If you were looking for a signal of how far the market has come, this is it," said one of the bankers involved in the trade.

"This is a triple B rated bond, with deferral features and 20 year extension risk. That this trade could get done is a testament to the whole financial institutions sector. It also shows you the maturity and sophistication of the UK investor base and shows that if they understand something and are comfortable with it, they will buy it."

That investors could easily understand the rational for the trade clearly helped the deal.

"We had done a non-deal roadshow this time last year and felt that there was nothing to lose and lots to gain in seeking investors’ views," said Mike Harris, director, corporate finance at RSA Insurance Group in London.

"We wanted to explain why under the Insurance Group Directive, lower tier two with call and deferral features is still a relevant instrument for insurance companies and the measure by which the regulators assess capital adequacy. Lower tier two, upper tier two and innovative tier one are all also likely to remain relevant under Solvency 2."

Market participants away from the deal praised RSA for the quality of its investor work, adding that this had clearly paid off.

"In the non-deal roadshow, while most investors were comfortable around our credit and found it easy to understand, the structure took a bit of explaining," said Harris.

"Many investors told us that they believed this market was shut but that they would look at an RSA senior deal. However, as we explained the rationale and the impact if we do not call in 2019 via a step up of 50% of the initial spread, there was more and more appetite around the deal."

The step up was clearly something that investors felt comfortable with and that would protect them enough should the issuer decide not to call in 10 years.

As well as praising the deal for its very existence, market participants were simply amazed by the level RSA could achieve.

"For me, this was the highlight of the week," said a FIG syndicate banker away from the deal.

"This is the first time the market has priced a deal with deferral and extension risk for a long time and at a fantastic level for the issuer at that, especially if you compare it to Barclays’ lower tier two which in light of this deal looks like the worst trade of the year, although you do have to take into account the exchange dynamics in the case of Barclays."

Other bankers cited a private placement done for another insurance company, said to be Aviva, a 10 year non call five that priced at 760bp over.

Another FIG banker was also impressed by the level. "I was staggered by how tight they managed to price the deal and it shows what can be done when you present your credit well," he said.

The transaction priced at 565bp over mid-swaps and carried a 9.375% coupon. The original guidance had been 575bp-600bp, reflecting the wide range of feedback received by the leads during the discussion process with investors.

"Following an initial sounding of a number of key accounts, we were in a position to launch. Some large initial orders from strong investors gave us momentum and were able to feed that back to others who were initially more reluctant," said Harris.

Rabo leads euro way

RSA was the highlight of the week but that takes nothing away from Rabobank which reopened the euro lower tier two market after a nine months hiatus.

A fresh benchmark is now available for the market to reference. The pricing at 240bp over mid-swaps was around 90bp back of senior bonds. This was tighter than the original guidance of 250bp over.

"It is always nice to be able to reopen a market which has been essentially closed for a long time," said Michael Gower, head of funding at Rabobank in Utrecht.

"The market had improved dramatically and we have had significant reverse enquiry for lower tier two assets from a number of our key investors for quite some time."

The bullet structure was chosen as extension risk is clearly a much sorer point with continental that UK investors.

"The reason why we opted for the bullet structure was because investors have a preference for a non-call structure given recent market events and uncertainties around callable lower tier two," said Gower.

While the depth of the demand for the deal was impressive, so was the number of accounts involved. Indeed, at 140, this is a much higher number than on previous lower tier twos.

Hélène Durand

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