Ever since the financial crisis, regulators have been debating how much capital banks should hold on their balance sheet and in what form. Last October, the Swiss announced their views on the topic. Systemically important Swiss banks, in other words Credit Suisse and UBS, would have to hold total capital equivalent to 19% of risk-weighted assets on their balance sheets, including 9% of contingent capital – bonds that convert into equity when certain trigger points are breached.
The ‘Swiss finish’, as it quickly became known, prompted a flurry of debate. Global and local bankers as well as investors grappled with how contingent convertible capital instruments (CoCos) would work and who would buy them.
Even today, there are fierce differences of opinion. Last month, UBS chief executive Oswald Grübel described CoCos as “a very dangerous instrument". Yet, only two weeks earlier, Credit Suisse issued $2bn of CoCos to an almost rapturous reception and persuaded major shareholders Qatar Holding and the Saudi-based Olayan Group to take a further SFr6bn ($6.6bn) of similar instruments in 2013, in exchange for Tier 1 capital notes issued at the height of the financial crisis.
Strong support
“Our bank has always been a strong supporter of CoCos in discussions with the regulators and investors. But, after all the discussions, we felt the time had come to show we could put the talk into action,” says Credit Suisse group treasurer Rolf Enderli.
The deal with the bank’s Gulf investors came first, structured as a private placement and satisfying 50% of the new Swiss rules on contingent capital.
“The private placement really set the pace, especially as it satisfied half our contingent capital requirements. Investors could see we were not wholly dependent on the public market and it allowed us to be more selective,” says Mr Enderli. Nonetheless, Credit Suisse was keen to press ahead with a public transaction as well.
“Part of our objective was to prove to the market that CoCos could be issued. Arguably, the private placement did not prove they could be done from a market perspective so we chose to do a public transaction as well,” says Kim Fox-Moertl, head of capital management in Credit Suisse's group treasury.
The process was unusual but rather clever. On February 14, the private placement agreement was unveiled, under which notes will convert to common equity if Credit Suisse’s Tier 1 capital ratio falls below 7% or the Swiss regulators decide it needs external support to prevent it becoming insolvent.
Benchmark deal
On the same day as this announcement was made, Credit Suisse said it was launching a benchmark contingent capital deal in the public markets. But the bank gave no fixed amount and precious little guidance on pricing either.
“We did not talk about the price or the size because we wanted people to focus on and understand the structure. Once they understood that, we started to talk specifically about the product,” says Ms Fox-Moertl.
“It’s probably easiest to think of it in three parts. The first part is the host instrument, a 30-year subordinated debt issue, callable after five and a half years. The second part is the trigger, the point at which the bonds convert to equity. The third part is the conversion itself,” she says.
The trigger points are the same as for the private placement – in other words, one objective, measurable trigger and one more subjective trigger, which depends on whether regulators believe Credit Suisse is viable or not. Either way, if conversion did take place, it would be at the market price on the day, subject to a $20 floor, meaning bondholders are at risk if the shares are below $20 at the time of conversion.
Under Swiss law, companies need shareholders’ permission to issue new shares. Credit Suisse already had an agreement in place, allowing it to issue up to 100 million new shares, which meant the maximum amount it could raise from the CoCo transaction was $2bn.
“We had planned to issue more than one transaction in more than one currency,” says Mr Enderli. “And we were thinking of a coupon of 8% to 8.5%. But, as time went on, we realised we could price it more tightly.”
Extraordinary demand
Ultimately, the coupon was priced at 7.875%: even so demand was extraordinary. Orders came in for $22bn of bonds so, even though the deal was as large as it could be – $2bn – investor allocations had to be drastically cut back.
“We could have priced it more tightly if we had concentrated on private investors, but because we were starting a new market, we wanted to include institutional investors and they wanted a certain price,” says Mr Enderli.
“Everyone was cut but we tried to treat everyone fairly and get a mix of institutional and retail across different industries and geographies,” adds Ms Fox-Moertl.
In the event, real money funds took two-thirds of the notes and hedge funds took the rest. Geographically, more than half the buyers were European institutions, with Asian retail taking 16%, Swiss retail taking 11%, Asian institutions taking 8% and European retail taking 7%.
Work to do
Despite the enormous demand, it was no done-deal, requiring months of discussion with regulators, lawyers and the bank’s own debt capital markets specialists.
“We needed to get something acceptable to regulators, to Basel and to investors. The non-viability clause required a lot of education because we were the first bank to include it, but Basel requires it so it had to go in,” says Mr Enderli.
“When fixed-income investors stopped to think about it, they realised that an instrument which converts to shares at least gives them the opportunity to share in any future upside, rather than simply suffering a write-down if the bank hits problems,” says Ms Fox-Moertl.
The success of the deal implies investors can see the merits of buffer capital notes. Credit Suisse now has 70% to 80% of its requirements but is asking shareholders for permission to issue more new shares if necessary at its next annual general meeting. There could be more CoCos to come.
