Santander’s announcement of a €2 billion preference shares-for-equity exchange on December 5 is the latest move by the Spanish bank to meet its goal of core capital in excess of 10% by June next year.
In its third quarter results announcement at the end of October, Santander registered a 13% fall in profit to €5.3 billion but chairman Emilio Botín was defiant, stating: “Our strong capacity to generate profit and the soundness of our balance sheet will enable us to exceed new capital requirements without the need to issue capital while maintaining our remuneration at €0.60 per share in 2011.”
The preference share swap, coming hot on the heels of the bank’s contentious tier 2 senior exchange, shows the extraordinary efforts required to meet this goal. At the end of the third quarter Santander’s core capital ratio stood at 9.42% and it has embarked on a series of divestments – such as a 7% stake in Santander Chile – to bolster its capital base.
Santander’s offer to swap €5.5 billion and £1.1 billion tier 2 bonds at cash prices of between 87 and 99.5 into four year senior unsecured notes has triggered a furious backlash from investors. The take up rate for the offer was just 25%. It has also raised worrying questions about why the Spanish bank decided such an aggressive move was necessary.
"The message of doing an aggressive liability management exercise is that the institution is in a more difficult position than was thought," states the head of FIG DCM at one London-based bank. Investors have particularly questioned why Santander is swapping tier 2 instruments for those higher up the capital structure.
The tier 2 swap, which could realize a €640 million tier 1 gain for the bank, has antagonized investors who object to surrendering a callable instrument in return for one that is very unlikely to be either called or to trade at par.
Although other banks, notably BNP Paribas, have also launched junior debt exchanges Santander’s offer has drawn particular ire.
"The market views this trade as a one-off," said Sue Wallace, head of European financials credit trading at Citi at a recent conference. "People still believe that national champions are still prepared to call. It is a sign of strength.”
Wallace cites the recent call of a Banca Intesa sterling deal as evidence that other banks from distressed sovereigns are still prepared to call deals. But the funding challenges that many banks face has made investors nervous.
"The Intesa sterling tier 2 deal that was called on 30 November was trading the day before at 95,” said Wallace. “People don’t believe the call notice until they see it. There have been some very strong investor statements on the back of [the Santander deal]. Issuers need to do investor-friendly trades. The way issuers behave towards investors will become more and more important. Investors have such a range of options for investment and issuers need to be aware of this."
As more and more banks undertake liability management exercises (particularly swapping out of old-style tier 2 instruments) to shore up capital levels, bankers warn that they need to be particularly conscious of investor reaction in such febrile markets.
Lloyds recently announced a £4.9 billion tier 2 swap for new lower tier 2 10-year non-call 5 notes and Barclays announced a subordinated debt tender on Monday, offering to purchase for cash up to £2.5 billion across six hybrid securities which have a total amount outstanding of £3.7 billion. Prices range from 70 to 94.5.
"There are a very limited number of issuers that would not think carefully about the ramifications for investors of aggressive liability management exercises," says the FIG head. "They don’t have room to be cavalier with the investors that are going to support their long term financing plans."
