Since emerging from RBS's investment banking business, NatWest Markets has become a major player in the FIG DCM space in the EMEA region and Canada. Edward Russell-Walling looks at the deals that have underlined this success.

Team of month 0719

From left: Harsh Shah, James Marriott, Phil Pearce, Tristan Whittingham

Royal Bank of Scotland's investment banking business, slimmed down and renamed as NatWest Markets, has been focusing on debt capital markets (DCM), and with good effect. Its financial institutions group (FIG) DCM business has become one of the fastest growing in the industry.

"We are very strong in financial institutions and we have grown the FIG franchise," says Harsh Shah, NatWest Markets' head of financial institutions origination and solutions.

A growth story

To be more specific, NatWest Markets' FIG DCM volumes in euro and sterling products have risen steadily from outside the top 20 in Europe, Middle East and Africa (EMEA) and Canada in 2015, to sixth place in 2018 and second in the first quarter of 2019, according to Bloomberg.

In that first quarter, the bank led all FIG DCM activity in the UK and Ireland, EMEA's largest pool of business. While it is not a big player in the US dollar market, it intends to grow that side of the business in the future, starting with yankee bonds.

One of the keys to the euro and sterling growth has been a more integrated approach, the bankers say. "We have truly integrated the solutions, DCM and advisory businesses," explains Mr Shah. "We are all on the same floor and we pool expertise when solving problems. DCM discussions tend to morph into solutions discussions, and vice versa."

The team is active across all European jurisdictions, and has been central to a number of new developments in the FIG primary markets, according to James Marriott, global head of FIG DCM. "The development and establishment of restricted tier 1 [RT1] and Sonia [Sterling Overnight Index Average]-referenced covered bonds have been two material milestones," he says. "NatWest Markets has worked with regulators, issuers and investors to establish these new markets."

Making an RT1 mark

RT1 debt is the European insurance industry's equivalent of additional Tier 1 (AT1) capital for banks. It is junior subordinated debt that qualifies as loss-absorbing capital under Solvency 2 regulation – perpetual, with a minimum five-year call, no step-ups and non-cumulative coupons. If triggered, it either converts to equity or is written down.

NatWest Markets was joint lead manager and joint structuring adviser alongside HSBC for the first public sterling RT1 deal in December 2017. The UK's Direct Line priced £350m ($446m) perpetual non-call 10-year RT1 notes yielding 4.75%, at the tight end of guidance. At the same time it bought back £250m of its outstanding £500m 9.25% Tier 2 notes.

The notes were convertible into equity should a trigger event occur. The transaction was more than four times oversubscribed, with interest mainly from the UK but also from Switzerland, the Benelux countries and France. Taken together, the deals were broadly neutral from a solvency coverage perspective, but improved the quality of the issuer's capital composition.

Tristan Whittingham, NatWest Markets' head of insurance DCM, points out that insurers are not under pressure from regulators to issue RT1 in the same way as banks and AT1. For issuers, it is often more a matter of timing.

"There is not a flood of RT1, because it is less regulatory-driven," says Mr Whittingham. "But it can be used to optimise capital structure. It is cheaper than equity and the rating benefits can be greater." RT1 can also play a role in financing mergers and acquisitions, he adds.

A leading role

In the nine RT1 issues to date, NatWest Markets has been joint lead manager on five and structuring adviser on three. "These transactions and the prior regulatory engagement on the development of the RT1 instrument has provided us with an enhanced level of credibility when we talk to European issuers," says Phil Pearce, head of FIG hybrid capital and liability management at NatWest Markets.

The bank was joint lead manager and joint structuring adviser with HSBC on the first sterling RT1 deal to feature a permanent write-down loss absorption mechanism. In 2018, Phoenix, a UK closed life fund consolidator, issued £500m RT1 notes at 5.75%. The proceeds partly financed the issuer's £2.9bn acquisition of Standard Life Aberdeen's UK and European life insurance business, while helping to maintain its leverage ratio.

In mid-2018, with NatWest Markets as joint dealer manager, Dutch insurer Vivat issued €300m perpetual non-call seven-year RT1 bonds with a 7% coupon, and a partial write-down mechanism. It also bought back €150m of its outstanding 9% Tier 2 capital notes. This increased its Solvency 2 ratio and improved its quality of capital. It also reduced the Fitch financial leverage metric.

From Libor to Sonia

The transition from the London Interbank Offered Rate (Libor) to Sonia as the primary sterling interest rate benchmark was brisk enough in the derivatives markets but slow to catch on in DCM. That began to change when the UK's Financial Conduct Authority, Libor's regulator, said it would not compel banks to submit Libor rates after the end of 2017.

In 2018, the European Investment Bank chose to help establish Sonia in the bond market, by issuing the first benchmark-sized transaction linked to the new rate. Its £1bn floating rate note, upsized from £500m thanks to demand, offered a 35 basis points (bps) spread to Sonia. NatWest Markets was a joint lead.

The team was part of the Bank of England working group on the reform of sterling risk-free rates. It has worked with FIG and sovereign, supranational and agency borrowers, hosting various workshops on managing the shift from Libor to Sonia. As with RT1, the bank has also helped to educate potential Sonia-linked investors.

The market in Sonia-linked covered bonds from UK FIG borrowers has been particularly lively. The first came from Lloyds Banking Group in September 2018 – a three-year £750m bond with a 43bps spread. Royal Bank of Canada followed almost immediately with a one-year £350m issue priced at Sonia plus 25bps.

In the same month, NatWest Markets was joint bookrunner on Santander UK's inaugural three-year £1bn Sonia-linked covered bond, paying 43bps over Sonia. The £1.25bn order book from nearly 60 investors reflected gathering demand for this new product. "Sonia offers more definition in a market that has been opaque," says Mr Shah.

NatWest Markets says it ranked number one in Sonia-referenced covered bonds between the market's inception in September 2018 and the end of the first quarter of 2019. It has been on 11 out of a total of 19 deals, including two taps which it executed on a sole basis.

The transactions on which the bank has been joint bookrunner include Yorkshire Building Society's £500m five-year deal with a 60bps spread; Nationwide Building Society's £1bn five-year, plus 75bps; TSB Bank's £500m five-year, plus 87bps; NatWest’s own £750m four-year, plus 60bps; Skipton Building Society's £600m five-year, plus 68bps; Virgin Money's £500m five-year, plus 70bps; and Leeds Building Society's £600m four-year, plus 62bps.

Moving markets

Mr Marriott adds that, alongside the EMEA business, NatWest Markets has been able to re-establish its presence in Canada, where it ended 2018 with a number four ranking in covered bonds.

"Another key theme of the team's recent work has been innovative liability management," says Mr Marriott. One example was Coventry Building Society's tender for any-and-all of its outstanding £400m 6.375% AT1 issue. This was the first of its kind for a Capital Requirements Regulation (CRR)-compliant AT1, and NatWest Markets was sole structuring adviser and joint bookrunner.

The tender went hand in hand with the issue of a 'materially similar' £415m perpetual non-call five-year AT1 at 6.875%.

The bank was also a joint bookrunner on Yorkshire Building Society's debut £275m six-year non-call five-year senior non-preferred bond. This accompanied a tender for the issuer's 2024 non-call 2019 Tier 2 notes, the first for CRR-compliant Tier 2 capital notes within five years with no like-for-like replacement.

"We take the strong view that RT1, Sonia-referenced bonds and innovation in liability management are key issues for the market," says Mr Marriott. "They are complex issues and we have spent a lot of time working through the complexities with regulatory bodies and our clients. That gives us a lot of relevance with issuing clients and investors."

Mr Shah concurs. "Innovation is important to everything we do," he says. "It's at the core of our business."

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