Fri Nov 29, 2013 9:19am EST
* UK mutuals eye rule change to allow CCDS issuance
* Fixed income and equity investors put faith in Nationwide's future
* New capital instrument proves more risky than Additional Tier 1
By Helene Durand and Aimee Donnellan
LONDON, Nov 29 (IFR) - Nationwide Building Society did what many thought impossible this week and placed high risk equity-like capital with fixed income funds - a move that showed just how far traditional investors can be stretched to get a double digit payout.
The UK's largest building society sold GBP500m of Core Capital Deferred Shares that offered investors a 10.25% distribution.
"This is a true perpetual and a deal people said couldn't be done," said Andy Townsend, treasurer at Nationwide.
A banker involved in the deal said it would provide the UK regulator with a blueprint for funding the mutual sector, and Nationwide's success will encourage other UK mutuals to do what is necessary to allow the issuance of such deals.
"I suspect that most building societies will be changing their rules at their next AGMs so they have the option to raise this kind of capital," said Chris Parrish, head of group treasury at Yorkshire Building Society.
Investors have grown accustomed to ever riskier structures being sold by banks throughout this year as the Additional Tier 1 market has developed, but Nationwide took the market a step further.
Unlike the new breed of hybrids sold by banks in 2013, where coupons are fixed and there is a call option, CCDS are truly perpetual and distributions are variable and completely discretionary. So while the 10.25% pricing looks attractive, there is no guarantee that investors will get this level - or, indeed, anything at all - in the future.
This makes the instrument much more akin to equity, and yet it does not confer proportionate voting rights, while distributions are capped at 15%, limiting the potential upside.
"In the last six to 12 months, investors have had to think in a different way as banks started to sell Additional Tier 1 instruments and investors have come a long way," said Townsend.
"It wasn't an especially large step for them to go from Additional Tier 1 to CCDS."
The GBP1.6bn order book, which was heavily skewed towards real-money accounts, suggests there is a market for these securities, and potentially even more aggressive structures.
TEMPTATION
With UK banks' dividend yields hovering in 5% to 6% territory, it is not hard to see why many would be tempted.
At the onset of the exercise it was expected that Nationwide's instrument would largely end up with equity funds. But that proved not to be the case.
"We ended up selling this overwhelmingly to the usual suspects and there was an enormous overlap with the investors we sell senior and covered bonds to," said Townsend.
Yet, even more than with Additional Tier 1, investors are relying on the issuer to keep its promise on distributions.
"This has the potential to be volatile but you go into this with your eyes open," said Fiona Dickinson, an investment director at Standard Life Investments. "They aim to have stable distributions, but there is no guarantee that will happen."
Joint leads were Bank of America Merrill Lynch, Barclays, JP Morgan Cazenove and UBS, while Rothschild was structuring and financial adviser.
FINDING A HOME
Real-money investors may have dominated the order book but the leads had to work hard to find a home for the instruments.
"We bought it but for one fund only, our Strategic Bond Fund, which is where we have flexibility," said Daniel McKernan, head of sterling investment grade credit at Standard Life. "We couldn't justify it for our other bond funds as they exclude equity and this is effectively equity."
He added that a limited number of issuers would be able to do this type of trade. "For investors to buy, you have to be comfortable with management, the fundamentals of the credit and the governance."
For some fixed income investors, this was a step too far.
"This is categorically not a fixed income instrument. It's plain ordinary equity without the voting rights," said Robert Kendrick, a FIG analyst at L&G. "There is no way you can dress it as a bond."
Moves among mutuals to replicate the trade, in fact, have already been set in train, with Coventry Building Society, one of Britain's biggest mutually owned financial companies, changing its mutual rules, and announcing the changes in July. This will give the issuer the option to sell this kind of instrument despite the fact it is very well capitalised.
"Nationwide has been three years in the pipeline and now that it has arrived, attracted such an impressive order book and traded up in the secondary market. It definitely looks a good deal for them," said Lorne Williams, Treasurer at Coventry Building Society.
Skipton Building Society is also interested in the structure. "We will watch with interest to see how the market develops for this innovative instrument," said Jeremy Helme, Skipton's head of capital markets.
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