Bank of America is always interested in diversification, leading it to do more issues in non-dollar markets. Its team came up with the idea of issuing US trust preferred securities in sterling and achieved upper Tier 2 pricing despite a Tier 1 classification. Edward Russell-Walling finds out how the team did it.
When does a Tier 1 capital securities issue command an upper Tier 2 spread? When the securities are US trust preferred. It was only after Bank of America Corporation launched Europe’s first such deal that people wondered why no-one had thought of it earlier.
Early in August, Bank of America issued £850m of 30-year hybrid stock known as trust preferred securities (TruPS). This self-led transaction was the largest sterling-denominated Tier 1 offering yet seen by the market. More notable still, it was the first time that any US bank had sold Tier 1 debt in a currency other than US dollars.
The seeds of the transaction were sown in late 2004, in a meeting at Bank of America’s headquarters in Charlotte, North Carolina. Tom Houghton, head of funding, was in the chair. The subject was the holding company’s capital needs for 2005 and how to satisfy them. Two bankers present had travelled from London, where Banc of America Securities Limited’s international capital team is based. They were Ian Harjette, European head of FIG for debt capital markets (DCM), and Nik Dhanani, vice-president in charge of DCM capital solutions.
Non-dollar issuance
Bank of America Corporation was interested in opportunities to raise Tier 1 capital during the year. Much of it would be funded in the domestic US institutional and retail markets, as it always had been. “But we are always interested in diversification,” says Mr Houghton. “And over the last three years we have been doing more issuance in non-dollar markets.” So the London bankers promised to come up with ideas for non-dollar alternatives.
The US’s Tier 1 structure of choice is the TruPS, a hybrid that (at least for now) can be treated as debt for tax purposes and as capital when it comes to regulatory treatment. It gets its name from the fact that the issuer creates a trust (invariably in Delaware), to which it issues debentures. The trust then sells preferred securities to investors, carrying the economic right to the payments received under the debentures.
So TruPS was the inescapable choice. The question was exactly which variant would appeal most to European investors and which currency denomination would serve it best.
TruPS constraints
The TruPS format imposes certain constraints. “US regulatory rules for Tier 1 TruPS have three main criteria,” says Mr Dhanani. “The structure must have a minimum 30-year legal maturity. It must allow payment deferral for at least five years. And the transaction must take the structural form of trust preferred securities.”
Although the US Federal Reserve permits call provisions for this type of issue, it does not permit coupon step-ups. This reduces the attractions of a callable TruPS for institutional investors, who are accustomed to the step-up facility. “So we felt a 30-year non-call 10 issue was less appropriate,” says Mr Harjette. “Instead, we decided on an institutionally-targeted 30-year bullet.”
Currency choice
That decision taken, it remained to select the optimum currency: sterling or euro? “The sterling buyer base is dominated by 10 to 15 very large UK insurance companies and pension funds,” says Brian Robertson, co-head of international syndicate. The nature of their business gives them an appetite further out along the curve and they have a revived interest in 30-year paper, he says. “This is one of the deepest 30-year markets outside the US dollar, and [investors] will always look at new, high quality names at that point on the curve.”
Certainly, these big UK institutional investors are inclined to welcome any new opportunities at the long end. They have a reawakened zeal for matching their assets and liabilities as closely as they can. At the same time, many are approaching their individual limits on the short list of financial institutions that issue long-dated sterling bonds – invariably the large UK clearing banks.
This solid and well-defined investor base, geographically concentrated, was a persuasive argument in favour of sterling. The argument for euros was coloured by concerns over the relative under-performance of recent long-dated euro issues.
“It’s not that there wasn’t a deal to be done in euros but there wasn’t the same confidence in the long end of the market,” says Mr Robertson. “We felt that the execution we could achieve in sterling would be more favourable.”
Selling the issue
With the decision to issue into the sterling market made, the deal team invited Royal Bank of Scotland to join the transaction given both its expertise in the UK market and past experience in working with Bank of America. That was just the start. While TruPS are more or less commoditised instruments in the US, they were a complete unknown to sterling investors and they differ from typical European hybrid Tier 1 structures in a number of important ways. As a result TruPS are rather more debt-like and so cheaper to issue.
One obvious difference is that they are dated, with a hard, legal maturity. With the more commonplace perpetual/callable/step-up Tier 1 security, investors rely for redemption largely on the issuer’s concern for its reputation in the market. “With a dated TruPS, there is no extension risk and we felt this was an advantage,” Mr Dhanani says. Secondary trading levels of recent transactions that exclude step-ups suggest that investors may demand another 40-50 basis points (bp) to compensate for extension risk, he says.
Typical European hybrids feature unlimited and non-cumulative payment deferral (though some now include a stock settlement provision). TruPS have cumulative deferral, during which unpaid coupons accumulate, and the issuer may only defer coupons for up to five consecutive years.
Gauging opinion
The Bank of America team’s first move was both to educate and to sound out the market. “We met a series of large opinion-forming accounts to test the TruPS concept and got a very good hearing,” says Mr Harjette. “We felt the deal was do-able, recommended to Tom Houghton that we go ahead, and began working up a sterling document.”
This was the first capital securities offering and the first debt offering to be documented off a Securities and Exchange Commission-registered prospectus following the implementation of the EU Prospectus Directive, which raised a few intricacies of its own. After four weeks’ work on the documentation, it was time for the road-show. “It was the heaviest schedule I have ever done, because of the huge numbers of investors who wanted to see us,” Mr Harjette recalls. “The UK market has always been very receptive to new ideas.”
While the team would normally have settled for a series of one-to-one meetings with potential investors, demand was such that they threw a lunch at the City of London’s Great Eastern Hotel. Forty-five people turned up and in this rarified world, that is a crowd. “It was one of the fullest London lunches I have ever seen,” says Mr Dhanani.
Some accounts needed to know a lot more about the structure. Others, more familiar with US bank trust preferred offerings, were more concerned with the valuation context, especially in relation to the structure. The overall response, though, was overwhelmingly positive.
“It was clear we could do a benchmark-sized transaction in sterling,” Mr Robertson says. “That might be £250m-£300m but it was going to be a large liquid deal.”
When it came to price guidance, things got even more interesting. Given the twists in comparability, Bank of America took into account its own recent 30-year institutional dollar TruPS, as well as European upper Tier 2 benchmarks, before arriving at price guidance of around 90bp over gilts.
Tremendous response
Orders worth nearly £1.6bn came in rapidly and the issue size was raised to £850m. With a coupon of 5.25%, the reoffer spread to gilts was steady at 90bp. “Through intensive investor education, we ended up pricing at upper Tier 2 levels despite the ‘Tier 1’ classification of the structure,” says Mr Robertson. “Everyone agreed it was a tremendous deal.”
The pricing came tantalisingly close to the point at which the bank might have closed a domestic US deal. It certainly provoked a flurry of calls from other large US banks, keen for more details, though whether there will be many similar deals remains to be seen.
“We have had a very good experience with this structure but it will be of relatively limited appeal for most other US banks,” Mr Harjette concludes. “Currently, they are able to raise all the TruPS finance they need in their own back yards. The exceptions to this may be our peers, the top five US banks.”
