Senior non-preferred: CASA opens new segment

Crédit Agricole launched the first senior non-preferred benchmark on 13 December, just days after the respective French law became effective and in the wake of the European Commission proposing EU-wide adoption of such an instrument. Crédit Agricole’s Olivier Bélorgey and colleagues at sole bookrunner Crédit Agricole CIB discuss the landmark.

Was issuing the first senior non-preferred deal an objective of yours?

Olivier Bélorgey, head of the financial management department, Crédit Agricole: It was not really an objective. However, we felt that we had the strength and the legitimacy to offer investors a new asset class because right now we are among French banks the one with the strongest ratios — in terms of CET1, total capital, and TLAC, with no shortfall anywhere — and rank third among European G-SIBs. We have a total ratio of 19.2%, and if you add in 0.5% for Tier 2 debt that has a remaining maturity below five years and is therefore not taken into account in regulatory ratios but still counts towards TLAC/MREL ratios, it makes 19.7%, which — given the amount of our RWAs — equates to around Eu100bn of protection ahead of this new asset class.

And the corollary of that is that Crédit Agricole’s needs by year-end 2019 are quite small versus its peers. For that reason, setting the benchmark for this new segment ahead of our peers made sense. The market understood clearly that they wouldn’t have to require any kind of premium for strong supply that might have polluted the first reference for this new instrument.

Bernard du Boislouveau, FI DCM, Crédit Agricole CIB: That’s also a reason why a bullet structure was chosen instead of a callable — to offer a pure benchmark that is based on the quality of the balance sheet of the issuer in question and not polluted by external factors like call options, as we have seen in other similar segments. And a 10 year is the best possible benchmark in the euro market to reflect the issuer’s needs, market depth, and also the prestige of this long maturity versus shorter terms.

Bélorgey, Crédit Agricole: Regarding the timing, we had also indicated to the market in March, when discussing our Medium Term Plan, that we had Eu3bn to do per year in senior non-preferred before the end of 2019 but including 2016, because at that time everybody thought that the new French law would be approved more quickly than it was. The market of course fully understood that we had to postpone our plans a little given that the law hadn’t been voted on, but it was a good sign for the market that we try to deliver as soon as we could.

And it was good ALM management to issue before year-end so that we have a little less to do in 2017, because we had indicated to the market that we had Eu6bn to do before the end of 2017. All these figures have to be taken with some caveats due to possible external factors, but under the assumptions behind our Medium Term Plan we now only have Eu4.5bn to do in 2017.

To take a step back, what was the French government’s key aim of introducing this type of instrument, of which we have seen other variants in other countries?

Bélorgey, Crédit Agricole (pictured): I want first to mention that this solution was elaborated by the French banks globally and was the solution presented by the French banks to the French government as their preferred option.

We wanted to find a way to replicate for banks which do not have a holding company (HoldCo) and operating company (OpCo) structure a way to achieve TLAC requirements with a dedicated instrument — this new senior non-preferred is more or less the equivalent of the debt that is issued by the holding company of a bank with a HoldCo/OpCo structure.

Many investors asked us if we will continue to issue senior preferred debt, and so the answer is yes. Our total funding programme at Crédit Agricole SA level for 2016 was Eu14bn, of which we planned to do Eu4bn in hybrid instruments — Eu1bn of AT1 and Eu3bn of senior non-preferred — and although we have not yet disclosed the funding programme for 2017, if you imagine that they will remain in the same area of Eu14bn, then even with Eu4.5bn of senior non-preferred to do, you can clearly see that we still have reasonably large pure funding needs.

This really is an issue for every French bank because due to tax incentives a lot of household savings are going through life insurance companies or regulated savings accounts partially centralised to Caisse des dépôts et consignations (Livret A), and the loan to deposit ratio of French banks is over 100%, around 115%. So French banks still have a need to fund themselves in the wholesale markets even if they have to comply with very high TLAC requirements.

To what extent might this new instrument replace Tier 2?

Bélorgey, Crédit Agricole: It won’t, because in order to optimise the capital structure you have to retain 2% of Tier 2, or you can have perhaps 2.5% — each institution will decide. And if you want this instrument to be really different from Tier 2 in terms of pricing, you have maintain a Tier 2 layer of sufficient thickness.

You announced the deal on the Thursday, then had an intensive marketing period. What were the key messages you were getting across, and how did investors respond?

Bélorgey, Crédit Agricole: The facts demonstrate that investors understood the deal perfectly well because the total size of the book was above Eu5bn, which is quite unusual and very notable for senior debt.

There were questions about why we were issuing at this time, and on top of what I have already said it was because the market is good right now. We are in a windows market, so even if we were clearly just before Christmas, the market remained very bullish and we wanted to take advantage of that.

Investors also wanted us to confirm our needs in terms of bail-in-able debt, while other questions centred on the structure itself: Is it really a bullet? Is it really vanilla? There were a couple of questions on the ratings, too, because rating agencies’ methodologies for this instrument are clearly not at all alike and the outputs are very different: Moody’s rates this new bond Baa2, S&P BBB+, but Fitch A. Even if the rating agencies say that we shouldn’t compare ratings between agencies but with between issuers, it is remarkable to have such a difference. So even if investors are somewhat familiar with the rating agencies’ methodologies, they wanted me to confirm them and comment a little.

Doncho Donchev, capital solutions, DCM, CACIB: This difference in rating methodologies is anyway something already well known among investors. If we take the HoldCo issuance, the same rationale applies. Investors are used to that. Beyond these rating methodologies, investors were fully aware of the advantages for them of investing in this brand new instrument.

Du Boislouveau, CACIB: We also had various questions on the strategy — i.e. are you intending to go for a bullet trade, maturity, choice of currency, size of the contemplated transaction(s), etc — and the needs of Crédit Agricole globally, but no real specific questions from a pure structuring point of view, meaning that these investors were to a certain extent up to speed on this product. And indeed we saw that when we decided to go ahead on Monday the following week.

Bélorgey, Crédit Agricole: In terms of maturity and currency, we have answered that we will fulfil the vast majority of our needs in our two main currencies of issuance, euros and dollars, and that we will favour long-dated instruments. At the end of the day, our total needs for old-style Tier 1, Tier 2 and bail-in-able debt will be around Eu30bn, and if you don’t want to have amortisation concentration, you need to have rather long term instruments, and this means we will issue between five and 15 years for this new instrument.

Given the fact that we will anyway issue in euros and dollars and between five and 15 years, we didn’t have something specific in mind for this first deal, because we will adjust and adapt our maturity profile and relative needs in terms of currencies issue after issue. We were therefore absolutely listening to investors’ needs, indicating that we were fully flexible and that we will issue the deal in the currency and with the maturity fitting the biggest investor interest, and obviously in this instance this was for 10 year euros.

What do you think of the pricing outcome in relation to where senior preferred and Tier 2 are priced?

Bélorgey, Crédit Agricole: The trade came fully in line with our expectations for a first deal. And that was part of the core of my presentation: what rationale do you have to take in order to price this kind of instrument. We think that the first rationale is the capital structure, and the strength of the capital structure, the amount of capital and debt you have to protect this instrument. The second element is the supply and the amount you intend to issue, which can obviously have an impact on the price. For those two elements, we thought that we had some competitive advantage versus our French peers.

A way to consider the valuation of this instrument is to compare the price for bail-in — what kind of spread you have above senior preferred debt — relative to the price for subordination — the spread between Tier 2 and senior preferred. So if you calculate the ratio of the spread of this debt above senior debt, and the spread of Tier 2 above senior debt, you exclude the price of pure funding, pure liquidity, and you have the ratio between bail-in and Tier 2 subordination. And in our case, if you do the maths — and also take into account the fact that for a primary deal you have some need to pay a new issue premium, so work with the fair value of the deal — we issued with a ratio of around 30%.

Vincent Hoarau, head of FI syndicate, CACIB: We are paying 30% of the distance, so it’s a good result. Very few investors had a strong view that this product should price closer to Tier 2 than senior.

Overall, the price sensitivity was very limited and the performance in the secondary market proved we were spot-on, taking into account the size element. The bonds traded three basis points inside re-offer when the market closed for the year.

Michael Benyaya, capital solutions, DCM, CACIB: This new instrument is indeed closer to senior and also logically trades tighter than a HoldCo bond, having no downstream constraint on the use of proceeds. Actually, this new bond category benefits from a clear positioning in the waterfall and investors understood that perfectly.

That all seems very positive. Were there any particularly challenging elements to getting the deal done, apart from waiting for the law to come in?

Bélorgey, Crédit Agricole: Actually that was the biggest challenge. The main other point of discussion was the currency (choosing between US dollars and euros), because we had very strong interest in each, and it was a question of considering where the interest was the strongest. This was not an easy solution considering the very supportive feedback we had on each currency but the deal proves we made a very good choice.

Hoarau, CACIB: We considered all options in terms of maturity and currency, but on Monday everyone was screaming for a euro trade. Being a French bank, it was a little bit more natural to open up the domestic market before doing dollars, though feedback was extremely positive across the board and the pricing difference was marginal. Appetite for the long end was very clear after Draghi gave clarification on what’s going to happen in terms of QE, so the ground was there for a good trade.

Are you anticipating a broader interest in this new funding tool across Europe?

Bélorgey, Crédit Agricole: In its draft of BRRD2 the European Commission requires member states to introduce this new instrument into their national law — also giving some grandfathering for the German solution. At the end of the day, the idea is that across Europe you have effectively two dedicated instruments, one for TLAC and one for funding.

How did we achieve that? I think it’s because the so-called French solution is very simple: a new instrument very clearly positioned in the capital structure from the beginning to the end of the product. It fits an effective requirement. Allows to optimise the cost of the total TLAC requirement. Well, I think that’s why it has been adopted by the Commission. Of course, we had to go and see some other banks in other countries to explain what we have done, but we were very well received by the other banks globally, which had also lobbied towards their own governments to go that route.

Might you market this to retail?

Bélorgey, Crédit Agricole: Potentially yes, we could, but we will be very careful in terms of distribution, because if we do, we have to distribute it in a manner whereby clients will understand very clearly what kind of product they are buying, with no confusion between two instruments that can be called senior — senior preferred and senior non-preferred. So if we distribute it in our network, we will take all the necessary precautions, and perhaps we can also more or less dedicate it to private banking or something like that so that the product is very well understood, without any mis-selling.

Can you say anything further beyond what you indicated earlier in terms of 2017, even if budgets are not yet finalised?

Bélorgey, Crédit Agricole: We said that the funding plan is not yet finalised because of our ongoing budget process, and we do not yet know the needs of our businesses. But it shouldn’t be so different from 2016, in the same region but probably slightly above, at least because we will have to take into account the financing of Pioneer.