Epic issue proves to be groundbreaking deal

SG CIB’s Valérie Razou, originator in the sovereign-supra and agencies issuers team

SG CIB’s Franck Robard, director of the hybrid debt team

Eric Cherpion, director of European bond syndicate at SG in London

The recent Tier 1 bond issue by Agence Française de Développement (AFD) was the sort of groundbreaking deal that bankers love to get under their belt. The €300m perpetual, non-callable 10-year bond is the first Tier 1 issue from an Etablissement Public Industriel et Commercial (Epic), a state-owned public agency, and it is only the second directly issued Tier 1 deal since France introduced a law in August 2003 allowing for direct issuance rather than the use of a special purpose vehicle.

The deal, lead managed by SG Corporate & Investment Banking (SG) and Barclays Capital, was also enthusiastically received by investors; the book generated €1bn of orders in three or four hours. “It was a quick, efficient and extremely successful execution,” says Eric Cherpion, director of European bond syndicate at SG in London, which was also the structuring adviser to AFD.

In institutional investors’ search for yield, AFD’s bond offered a compelling proposition in balancing risk and return. “AFD offers quasi-government risk at a spread,” says Mr Cherpion.

Development remit

The hearty investor appetite for the paper and the complexities in structuring the note are both rooted in the status of AFD. Established as an industrial and commercial public organisation, it is responsible for implementing France’s economic and social development aid policy in sub-Saharan and north Africa, Lebanon, Palestine, the Indian Ocean and Pacific regions, the Caribbean, Asia and in the French overseas departments and territories. Its public interest mission is, therefore, underpinned by backing and a financial guarantee of last resort from the French government. As such, investors can be comfortable in the knowledge that, in the case of dissolution, the state assumes an Epic’s commitments (liabilities are directly transferred to the state or another public agencies). Its Epic status is unlikely to change in the near future.

Financial status

While its financial management is supervised by the state, AFD is also a “specialised financial institution”, which means it is also supervised by the Banking Commission (20% BIS-weighting) and must respect prudential ratios. According to Franck Robard, director of the hybrid debt team, the rationale behind this issue and its structure stems from its lending policy – as stipulated by the French government. AFD wanted to reinforce its regulatory capital – not to improve its solvency ratio (which is currently about 40%) but to bolster its “control for major risk” ratio.

“Because it is implementing government development policy, AFD has some significant exposure to specific high risk areas – such as Morocco and Tunisia – and the banking regulation states that its exposure should not exceed 25% of its regulatory capital in one particular area. This issue gives AFD greater flexibility to lend in accordance with French government guidelines,” says Mr Robard.

Issuance challenges

But its status as a government-owned agency did make structuring the note a challenging exercise. The mandate was awarded in February, but documentation and discussions with the regulator regarding the structure were only finalised around April 9. “That was partly because of the more complicated structure, but also because of the number of actors who had to take part in the discussions – including the issuer, the regulator, the French market authorities and the French government,” says Mr Robard.

In the first instance, SG had to establish that legally there was nothing to prevent an Epic issuing such an instrument. Secondly, Mr Robard says that while AFD’s paper shares the characteristics of a classic hybrid bond as defined by Basel regulations – ie, perpetual, non-callable before 10 years and a maximum 100 basis point (bp) step-up thereafter – it could not include the standard interest deferral clause because AFD is not paying dividends to the French State. (Under the clause, the seniority of Tier 1 debt over common stock is protected by triggering a compulsory payment of coupons if the issuer has declared or paid a dividend to shareholders.)

“We had to find a way to adapt this clause by finding another trigger. We decided on a compulsory payment and that the new trigger should be based on the assumption that AFD’s consolidated net income has to be positive,” says Mr Robard.

Another challenge was the stipulation that the note had to be Paris-listed – another first for a Tier 1 issue. “Getting approval from the French market authorities was helped by the fact that we had already worked with them to get approval for an earlier subordinated issue from Michelin, but it was still a fairly complicated process. It was difficult to convince them to accept the specific terms in relation to the risk of loss absorption, for example,” says Mr Robard.

Correct pricing

Getting the price right was also not as straightforward as with other Tier 1 issues, because there were no comparable assets in the euro or the dollar market.

Mr Cherpion says the bookrunners decided that the most efficient method was to look at a well-rated bank and find out the difference between its outstanding senior and Tier 1 debt. For example, if a AA-rated bank’s senior 10-year bonds trade at about mid-swaps plus 20bp and its outstanding Tier 1 paper trades at around mid-swaps plus 65bp, it gives a 45bp premium. “We felt that the pricing for AFD should be quite a lot tighter because of its ownership and the AA-rating of its Tier 1 paper. Given a senior 10-year bond for AFD typically trades around mid-swaps flat, we went to the market with a price guidance of mid-swaps plus 35bp-40bp,” he says.

According to market speculation, some other firms who responded to the request for proposal (RFP) thought the paper would surface at mid-swaps plus 55bp. Mr Cherpion admits that they initially thought 35bp-40bp was perfectly reachable, but did not imagine that the paper could ultimately be printed at plus 32bp.

However, the speed with which the book became three times oversubscribed quickly indicated that the price could be tightened still further and the bookrunners went back to investors with a guidance price of mid-swaps plus 32bp-35bp. Even at the new price investors almost bit bookrunners hands off in their eagerness to participate in the issue.

“The issue has also benefited from a favourable market context with a lack of supply in subordinated debt and a recent increase of the 10-year yield,” says Valérie Razou, originator in the sovereign-supra and agencies issuers team.

Mr Cherpion says the bond’s performance in the aftermarket has justified their decision to tighten the price. “Immediately after the issue, it tightened a bit further to 29bp, but has now stabilised at 30bp. That is a validation of our pricing methodology – we got it right for the issuer and the investors,” he says.

Broad appeal

Distribution was broad, with 24% going to France, 21% to the UK, 17% to Asia, 11% to Switzerland, 6% to Belgium and the Netherlands, 3% to Scandinavia and Austria, 2% to Greece, 1% to Germany and Portugal, and 5% to others. “There was far more international distribution than we expected,” says Mr Cherpion.

Final allocation, which was left to the bookrunners, was 40% to asset managers, 23% to banks, 19% to hedge funds, 16% to insurance companies and 2% to central banks.

While the specifics of the AFD deal will not be repeated by other Epics – as it is the only one that is regulated as a financial institution – SG’s experience of structuring and distributing AFD’s hybrid bond, alongside its previous work with Michelin, should stand the bank in good stead when pitching to secure similar deals. Mr Robard says: “The legal expertise we have gained during this transaction and in other deeply subordinated debt, can certainly be put to good use on other deals.”