Metro and Elis: a tale of two BB+ bonds
Metro Bank’s failed senior non-preferred bond is rated BB+, squarely in high yield territory. But while corporates with this rating print at ever tighter yields, Metro couldn’t get its deal away even at 7.5%. Nobody expects the rating agencies to be in line with the market, but sometimes the gulf is yawningly wide.
For investors focused on high yield, companies rated BB+ are a mixed bag. Most would prefer something a little spicier, credits with a story, and the chance to take a piece of an LBO financing. If a company is rated BB+, it’s probably a stable company, with reliable cashflows and no governance red flags.
Worse, it will attract ‘tourist’ buyers who usually focus on investment grade companies, seeking a little yield by heading away from the benchmark — and forcing high yield investors to pay up if they want the exposure.
Companies have got wise to this, and increasingly use investment-grade style executions — issuing unsecured bonds from main operating entities, using EMTN shelves, flat syndicate structures, and mid-swaps plus pricing.
French laundry firm Elis, for example, in the market on Tuesday with a long five and long eight year bond, and a BB+/BB rating, is set to come with a 1% coupon on the long five year and a 1.625% for the eight year, almost a record low for a sub-investment grade issuer.
In short, BB+ means quality and anaemic yields — for corporates.
For beleaguered UK challenger bank Metro, however, this BB+ stamp meant anything but. The firm has had a miserable year, following revelations in January that it had miscalculated its capital ratios. The bank’s business model, heavy on physical branches in premium locations and deposit growth, light on high margin lending, also came in for criticism from several sell-side analysts.
When the bank came to market this week for a senior non-preferred deal, which is designed to absorb losses, it did so with that same BB+ rating (from Fitch Ratings only) but a stonking 7.5% area talk for the sterling four year deal. Prevailing interest rates are much higher in sterling than in euros — more than 100bp, based on five year swaps — but the difference is still stark.
Nor was it enough. Metro Bank wanted a £200m-£250m deal — needed it, really, to meet regulatory requirements. But by 2pm on Monday, after a morning of bookbuilding, it had only £175m, and nothing more was forthcoming in the afternoon. The deal was pulled just before market close.
Now, there are clear credit differences between a bank and a corporate. When a bank collapses, senior non-preferred bonds are explicitly supposed to bear losses, and could easily recover nothing. By contrast, a senior corporate bondholder has a decent chance of extracting something of value from the wreckage, through a managed restructuring or even an insolvency. There’s no regulator standing in the way of recovery.
But that ought to be reflected in the rating — the whole point is to be able to compare apples with oranges, on a clear scale of credit quality. The agencies are sometimes uneasy about this role, and tag certain asset classes, such as securitizations or infrastructure, to make it clear that an AAA (sf) is different from a straightforward AAA.
Sometimes the issues are hard to feed into ratings. Some investors distrust Metro’s flamboyant chairman, Vernon Hill, and he agreed to step down this summer. But even this was supposed to be incorporated in those all-important letters. Fitch said there were “weaknesses… in terms of board independence and control oversight” when assigning its BB+.
Rating agencies have no obligation to match market views of default — and plenty goes into prices other than pure credit risk. But fundamentally, banks and corporates are competing for the same wads of credit investor cash, and bond ratings for both feed into the same mandate limits and investor reporting.
On recent market performance, though, they are not just different issuance styles… they are on different planets entirely.