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Categorized | Capital Markets

Concern at Intesa debt exchange offer


Posted on October 31, 2012

Investors and analysts are up in arms over the terms of a bond exchange offer made by Italy’s Intesa Sanpaolo, which some argue is “aggressive” and potentially “gamechanging” for bondholders.

The Italian bank last week announced that it would offer to exchange some of its existing tier two subordinated bonds for a new five-year senior bond.

    Greek government debtClick to enlarge

    Bond exchanges and debt buybacks have become commonplace among banks looking to replace expensive debt or find more collateral. But what is unusual about the Intesa debt exchange offer is that the Italian bank has amended the early redemption, or call, option on the notes and done so without consulting investors.

    The move is unsettling for bondholders as they see such call options as sacrosanct. Call options offer the ability for an issuer to repay debt early. While there are examples of other organisations not calling their bonds, investors expect borrowers to repay callable notes at the first opportunity and the notes are often valued on that basis.

    Intesa said that it did not “deem it appropriate to maintain its call-exercise policy in the existing market conditions” but would be offering investors a chance to exchange those notes affected with a new senior bond. It said those investors that did not take part in the exchange would see the call option removed so that the paper would be acceptable under new Basel III rules on tier two capital.

    Given the current economic environment, the worry is that other banks will decide not to call their bonds or adjust the language of their existing call options because it is either more expensive to refinance the debt or because of regulatory factors.

    There are concerns that so-called “economic calls” are becoming the trend.

    BBVA, for example, said in October that any decision to exercise the option to call some of its subordinated notes would take “into consideration the economic impact of such early redemption, the regulatory requirements and market conditions”.

    “We know that banks always have an option not to call a bond,” says Neil Williamson, head of European credit research at Aberdeen Asset Management. “And we were nervous on calls but we didn’t anticipate this step change . . . this kind of tactic leaves a sour taste in the mouth.”

    He says the risk to a bank is potentially reputational – if it fails to call its bond it may no longer be able to rely on those investors to support its next bond issue.

    Investors were angry when Deutsche Bank in 2008 broke with convention and decided not to exercise a call option on some subordinated bonds. But investors supported subsequent new issues of debt.

    Georg Grodzki, head of credit research at Legal & General, says the Intesa move is “unusual and un­helpful”, adding that it is rational that an issuer wants to change the terms in his favour, but he considers bondholders should be consulted and trustees should not act without their consent.

    Intesa said in its offer statement that the trustee, The Law Debenture Trust Corporation, was of the opinion that removing the call option was “not materially prejudicial to the interests of bondholders”.

    Mr Grodzki says the worry is that Intesa’s action “will open the floodgates” for other issuers trying to remove call options without involving bondholders. “This incidence will force investors to review their position,” he says.

    Analysts have questioned the rationale behind Intesa’s move since the new regulations on what kind of tier two capital banks must hold are being finalised. Intesa declined to comment.

    Ivan Zubo, European banks credit analyst at BNP Paribas says: “It’s yet to be seen what the [tier two capital] regulations will look like. But it is clear that Intesa could have done things differently . . . in general investors didn’t think that the premium was significant enough to offset such a change in policy. It’s a gamechanger. There’s no question about it.

    “I would be surprised if the management of other banks were not carefully looking at the issue and the market practice is progressively moving towards economic calls. But some will be wary about being associated with an action taken by banks in the [eurozone] periphery because it could be seen as a sign of weakness,” says Mr Zubo.

    Some investors and bankers argue that bondholders need to be more realistic.

    “The fact is there are banks where the cost of funding is higher than they’d like, especially in the periphery, and they don’t see why they should pay up to replace relatively cheap capital with more expensive debt,” says Stefan Isaacs, a fund manager at M&G Investments.

    “The bigger context is that banks are being pressed by regulators to increase their capital base and at the same time increase lending. You could argue that those two things are contradictory. But to then expect them to be as friendly to bondholders as they have been is a hope more than a reality.”