Soft bullet exchanges must be more open
On December 30, when most investors were on holiday, Credit Suisse changed the terms of its existing covered bonds from a hard to a soft bullet maturity with the approval of just a few investors. Other issuers looking to change the terms of existing deals should be more upfront about liability management exercises that could put investors at a disadvantage.
In late November the Swiss issuer published a consent solicitation, proposing to change the maturity of a number of existing covered bonds from hard to soft bullet maturities. The proposals were put to a vote on December 11, but Credit Suisse did not hit the necessary 75% quorum.
On December 30, a second vote took place, where quorum of just 25% of bond holders was required. That quorum was achieved with three quarters of those attending, which is 19% of all bond holders, required to approve the proposals. They did so for a fee of five cents while the remaining majority got nothing.
Many other covered bond issuers have programme documentation that allows them to issue soft bullet bonds, but none other than Credit Suisse have so far exchanged existing hard bullet bonds for soft bullets.
Barclays, for example, began by issuing hard bullet bonds, then changed to soft bullets. ING has a programme that allows it to issue both hard and soft bullet bonds, though so far it has only issued hard bullets. Last year the Dutch bank set up a new programme from which it will issue only soft bullets.
In both cases investors of the UK and Dutch deals were able to determine from launch what they were buying and what risks they were taking.
The difference in structures matters because of the usual soft bullet maturity extension of one year, followed issuer default. Because of this, there is a lower mismatch between assets and liabilities, so rating agencies require less collateral to achieve a given credit rating.
The switch to soft bullets therefore means that Credit Swiss can remove assets from the collateral pool that were originally in there to protect investors when it sold the deals as hard bullets.
The aversion to soft bullets was captured in an investor survey conducted by Fitch two years ago which showed that 21% of respondents would only buy hard bullet bonds. Another 47% said they would buy soft bullet bonds — but crucially only for a higher spread.
Attitudes have since softened and with covered bond spreads tightening due to technical factors, the market no longer differentiates on price between the two formats. As these technical conditions are likely to remain in place, and given the precedent now established by Credit Suisse, other issuers are likely to follow suit.
Should other issuers decide to press ahead with a similar exercise, they should make sure investors have a genuine opportunity to express their views, and they should value the real endorsement that an exchange with a large majority, on an ordinary business day gives to any changes.