HSBC financial institutions group’s capital-raising transaction for health insurer Bupa was complicated – but that did not faze the team in its efforts to coax bondholders out of old stock and into the new, writes Edward Russell-Walling.

Three years ago, for anyone talking debt origination in the European and Asian financial sector, HSBC would not have been the first name to spring to mind. Since then, however, a succession of eye-catching, capital-raising deals for banks and insurance companies has earned the bank some attention.

The recent £330m upper Tier 2 capital transaction for UK health insurer Bupa – jointly lead-managed with ABN AMRO – is an intriguing example of what HSBC’s financial institutions group (FIG) can do.

“Insurance is an interesting sector right now,” says HSBC managing director Nick Medd, global head of origination, corporate and financial institutions. As he points out, the Financial Services Authority (FSA) recently increased the capital requirements for UK insurers. “They are at the height of their capital-raising cycle, and so subject to a lot of attention from us and from our competitors.”

Taking the lead

Mr Medd, who previously headed the bank’s European debt capital markets operations, moved to his current job in 2003, just as HSBC decided to push strongly into financial institutions. At the same time, Bill Blain joined from Bear Stearns to head the new FIG team. “We have moved the whole franchise quickly forward, from being nowhere to being a leading player,” Mr Blain says.

The group has built an impressive show-reel in a short time – particularly, though not exclusively, by serving mid-size and less-courted institutions, such as European regional banks and UK building societies. Its transactions include innovative covered bond issues for UK building societies Bradford & Bingley and Northern Rock, and equally pioneering Tier 1 capital deals for insurers Friends Provident and Axa.

Reporting to Mr Blain are two directors: Fergus Blackstock, who is responsible for bank clients, and Simon Woods, who looks after insurance companies and so had hands-on responsibility for the Bupa deal.

Specialist area

“Insurance is a very specialist area,” says Mr Woods, a chartered accountant with previous experience in HSBC’s corporate finance department. “And the capital team for an insurance client is more multi-product than that for a bank. Origination is more holistic, strategically-driven as well as markets-driven.”

In the case of Bupa (which has HSBC as its relationship bank), the team worked closely with corporate finance, the bank’s ratings advisory group and liability management, among others.

Bupa is a rather rare bird. It is not only an insurer but also runs its own hospitals and care homes, which differentiates it from its so-called peers, either in insurance or in health care. As a provident association, it has no shareholders and no ability to raise equity finance; growth, whether organic or by acquisition, must be financed either by internally generated funds or capital raised in the debt markets. And a financial strength rating was deemed vital to access the capital markets.

HSBC worked with rating agencies Moody’s and Fitch, which eventually awarded Bupa A3 and A+ Insurance Financial Strength ratings, respectively. An important result of this exercise was the decision to reorganise what had been Bupa’s sprawling corporate structure.

Perpetual note issue

Bupa is “reasonably highly” leveraged, says Mr Woods. The first and last time it visited the bond markets was in 1993, when it issued £100m of 20-year subordinated debt. It also had a sizeable chunk of bank debt, “so what it needed was hybrid – in other words, quasi-equity – finance that would also qualify as regulatory capital”, hence the choice of a perpetual note issue, which would conform to upper Tier 2 requirements.

The original transaction stipulated that Bupa could defer interest payment only if it was in default or if triggered by a capital ratio breach. But as the first upper Tier 2 deal by a UK non-listed company, new ground was being broken. “And during the project, the FSA’s guidance changed,” Mr Woods says. “It decided that the issuer must have the unfettered option to defer.”

Responsible deferral could conceivably have been enforced by a dividend blocker, promising that if Bupa did not pay the coupon, it would not pay a dividend either – except that it does not have any shareholders. “As a way round, Bupa made a non-legally-binding commitment to defer only in certain circumstances,” says Mr Woods. Those were the default and capital ratio triggers that were originally stipulated.

All this may make the process sound simpler than it was; in fact, negotiations with the FSA went on for some time. The upshot was that upper Tier 2 capital for a mutual now looks similar to Tier 1 capital – more equity-like, that is. While this feature set the deal apart from more conventional transactions, it flowed from Bupa’s unusual status and probably has limited application elsewhere. An innovation that may be replicated, however, is the method whereby existing bondholders were bought out without getting in the way of the new issue.

The search for new money

It had been generally agreed that a buyback was desirable. “The company was looking for Ł200m of new money,” Mr Woods says. “Out there was Ł100m of old money (trading at Ł128m), unrated and with out-of-date guarantees. It was better to have a single, bigger bond that was rated and more liquid.”

If bondholders were to be coaxed out of the old stock and into the new, how could the team make sure that this process did not impair the execution of the new issue? “You need flexibility on opening and closing a new bond book, whereas a tender offer is a more fixed affair,” says Mr Woods.

The solution was to create a two-stage tender process. Stage one was an informal tender for the old paper during the marketing period for the perpetual note issue. “We built two books,” Mr Woods says. Informal though it was, this offer was dazzlingly successful. It attracted 88% acceptances from investors, who could not refuse the offer to switch at a price that maintained their existing yield. “Compliance had to be heavily involved, to monitor what we said, when and to whom, and to make sure that no investors were prejudiced,” says Mr Woods.

Then, to ensure equal treatment for any bondholder unable to take advantage of the informal tender, the company launched an identical but formal offer (still open at the time of writing): “We didn’t disadvantage anyone, but retained flexibility of execution.”

Wide appeal

If the existing bondholders were taken by the new offer, so too was the wider investment community. Once the roadshow was announced, interest grew rapidly. What started as a two-and-a-half day schedule (one-and-a-half days in London and one in Scotland, pitching to a total of 14 accounts) ballooned into a seven-day phenomenon, with about 30 one-to-one presentations.

Mr Woods says that the roadshow was packed. “Interest was huge.” The existing bondholders had already accounted for £130m of the issue. Once the new book was opened, some £1bn was chasing the £200m of new stock within the first six hours. “We had 94 accounts in the book,” he recalls.

Price guidance was cut from 170bps over gilts to 160bps. “At 170bps it would have been a good result, so another 10 points was the icing on the cake,” Mr Woods says. The quality of the book would have supported a considerably larger deal, but Bupa was content to stick at £330m of the Baa2/A- perpetual non-call 16 paper.

So it was a positive achievement all round, not least because the bond switch was achieved at a flat premium to the new issue price – for free, in other words. “That bit of liability management technology is something we’d like to see more of,” Mr Woods concludes. “We were amazed at its success – most people see a buyback combined with a new issue as just too complicated.”

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