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Team of the monthSeptember 1 2014

RBS helps revive sterling bond market

The UK sterling market has enjoyed a stellar 2014, with RBS playing a leading role in the surge with a series of innovative issuances that have proven popular both within and outside of the UK.
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RBS helps revive sterling bond market

The sterling bond market has been in good heart this year, helped by renewed life in the hybrid and covered bond segments. Its high-quality investor base has been attracting non-UK as well as British issuers and, appropriately enough, RBS has been one of the most active banks in the market.

RBS sees sterling fixed-income debt capital markets (DCM) as part of its natural stamping ground. “One of our stated strategic initiatives is to focus RBS as a strong UK bank that can help its domestic and international fixed-income clients access the UK capital markets, both inward and outward bound,” says Gordon Taylor, RBS head of fixed income DCM.

A new surge

While the supply of sterling bonds has historically been limited, UK insurer Prudential marked the start of the recent surge in December 2013 with an ultra-long Tier 2 deal. With RBS as a bookrunner, alongside Barclays, Bank of America Merrill Lynch, Citi and UBS, it issued £750m ($1.25bn) of 50-year non-call 30-year (50NC30) paper with a 5.7% coupon.

It thereby reopened the sterling long-dated callable capital securities market which had been dormant since Aviva issued a £600m 50NC30 Tier 2 hybrid in 2008. Prudential’s 'Solvency II-proofed' transaction paid no new issue premium nor any additional spread to move from 10 years to 30 years, and the deal attracted orders of £1.75bn. While both the volume and the number of orders were smaller than might have been expected for a more traditional 30NC10 structure, the transaction uncovered a strong seam of high-quality demand for long-dated sterling instruments. This did not escape the notice of other borrowers.

This year to the start of August has seen £11.6bn of sterling subordinated issuance, compared with £3.5bn for the whole of 2013. First up was not a UK institution, but France’s AXA, with a slightly more defensive 40NC20 Tier 2 deal. With RBS as joint bookrunner, the insurer enjoyed £3.75bn of demand and printed £750m with a 5.625% coupon. UK investors took 92% of the transaction, with 3% going to Switzerland, 2% to Germany and 1% to France.

In the run-up to Solvency II, the UK has been a pathfinder for capital markets. “The Prudential Regulation Authority [PRA] has been a leading force in shaping structures,” says Tristan Whittingham, RBS head of insurance DCM. “Our continental European insurance clients look to us and other UK banks for the direction of travel in terms of the final shape of Solvency II-compliant instruments, based on our experience with the PRA.”

Sterling appetite

While sterling’s natural investor base consists of UK insurers and asset managers, it has been expanding recently. “In the past six to 12 months we have seen a lot of investors proving currency agnostic and wanting to get into sterling bonds,” says AJ Davidson, RBS head of hybrid capital and balance sheet solutions. “These are predominantly located in the UK and they include multi-strategy asset managers and hedge funds.”

These investors like the company they are keeping, according to Harman Dhami, an RBS syndicate managing director responsible for fixed-income products. “They are sitting alongside a lot of high-quality real money accounts, who are not forced sellers in volatile markets,” he says.

So sterling investors are becoming more international in pedigree, even if they continue to be largely London-based. Mr Davidson believes that on most bank capital deals, even those not denominated in sterling, more than 40% of the order books is filled by UK-based accounts.

The sophistication of these investors is borne out by the success of a couple of innovative additional Tier 1 (AT1) deals in sterling. Nationwide opened the market with a £1bn 6.875% transaction in March, attracting £11bn in orders. AT1 capital must be loss-absorbing, and this was the first structure to convert not to common equity (Nationwide is a mutual) but to 'core capital deferred shares' (CCDS).

Sent to Coventry

RBS was joint bookrunner on the Nationwide deal, and sole structuring advisor on an even more innovative AT1 transaction for Coventry Building Society in June. “Nationwide’s CCDS were already issued and listed,” says Mr Davidson. “Coventry converts into CCDS that are not yet issued or listed, making this the only new generation AT1 transaction ever to do so.”

The Coventry deal attracted £3.25bn from more than 230 accounts, and £400m was priced with a 6.375% coupon, the lowest ever for a sterling AT1. While they have yet to be used by a non-UK institution, these structures could suit banking mutuals in jurisdictions such as Germany, Austria, Italy and the Netherlands. “The Nationwide and Coventry deals send a strong signal to similar mutual non-common stock banks in the rest of Europe,” says Mr Davidson.

As sterling continued to attract foreign borrowers, in April Crédit Agricole became the first non-UK bank to launch a sterling AT1 deal, followed by Deutsche Bank in May – RBS was not involved in either transaction. But it was joint bookrunner in April on Groupe BPCE’s 15-year bullet £750m issue – the first French sterling Tier 2 deal.

Scrapped annuities

Back in the insurance market, the UK budget in March gave pause for thought, by scrapping the compulsory purchase of annuities for defined benefit pension savers. “The sterling market has been renowned for its appetite for duration to match insurers’ annuity books,” says Mr Whittingham, who adds that given the success of subsequent insurance company issues, the market clearly believes the annuity business will survive in some shape.

One of these post-budget deals was from UK insurer Legal & General, returning to the subordinated sterling market for the first time since 2009. It raised £600m in a 50NC30 5.5% Tier 2 deal, with RBS as sole structuring advisor. The size was increased in response to a £2.25bn order book.

Following that, Pension Insurance Corporation was able to pull off an inaugural unrated 10-year Tier 2 deal, raising £300m at a coupon of 6.5%. The transaction illustrated one of the features helping to grow the market, which is that more investors are prepared to do the credit work on less familiar or unrated names. “There is a pool of liquidity for unrated issuers,” says Mr Dhami. “It’s smaller, but well-suited for hybrid products given the yields on offer.”

This year has also seen the reopening of the sterling covered bond market, with four deals so far. RBS has been active on all of them. First out of the gate in early January was Lloyds Bank, with a £1bn three-year floating rate covered bond priced at three-month Libor plus 30 basis points (bps). This was the first sterling covered bond trade in more than 18 months and the largest fully syndicated sterling three-year floating rate note to date.

Santander UK followed a week later with a £750m floating rate covered bond, priced at three-month Libor plus 35bps. While 80% went to the UK (compared with 93% for the Lloyds deal), there was a strong bid from Scandinavia, which took 13%. Germany and Austria took 4%.

A week after that, Commonwealth Bank of Australia also launched a covered floating rate note in sterling, raising £350m at Libor plus 35bps. More recently, Nationwide took advantage of the continuing appetite for sterling with a £750m three-year covered floating rate note. With orders of more than £1.5bn, it was able to price at a compelling Libor plus 23bps. It also uncovered some interesting pockets of demand. The final allocation included 5% for the Middle East and Africa and 6% for Asia, alongside 83% for the UK and Ireland, 4% for Germany and Austria and 2% for Switzerland.

There has been a respectable flow of sterling-denominated senior issues from non-UK borrowers this year, and RBS has been well-represented here too. It has acted on senior deals from Australia’s Macquarie, France’s BPCE, New Zealand’s ASB Bank and GE Capital of the US.

RBS is not expecting the level of interest in sterling to die down any time soon. “This has been a welcome and appropriate return to activity for the sterling market, which can see sporadic issuance patterns,” says Mr Dhami. “But its quality of demand and investor type is very well suited to sophisticated structures, and this is reinvigorating interest for Continental borrowers.”

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