· SNS is struggling with its capital repayment to the government – failure to achieve this could lead to renewed EU state aid investigations with potentially harsh remedies · Complicated capital structure and ongoing challenges in the property loan portfolio are key issues for the group · Hybrid instruments have somewhat unusual features. The 6.258% hybrid seems preferable to the 11.25%. Forthcoming capital measures could have important implications for hybrids and sub debt of the group and uncertainty for valuations ahead of this is very high, suggesting caution.
SNS REAAL is a Dutch banking and insurance group with long established roots in the country’s savings bank and labour movements. With total assets of €134 bn as at end-June 2012 it is the fourth largest financial group in the Netherlands. Its main focus of operation is on Dutch savings, investment, mortgage, property finance, insurance and pensions.
While the group’s main franchises are performing decently, it has and continues to struggle with high provisioning needs for an ill-timed acquisition of property finance activities from ABN Amro in 2006. This has prevented the repayment of government capital support which was injected in 2008 and needs to be repaid by the end of 2013 according to SNS’s agreements with the EU under its restructuring plan.
Without significant additional efforts it currently appears unlikely that SNS will be able to meet this EU timetable, and indeed there are reports in the press the group might need additional capital to buffer real estate losses irrespective of the government capital repayment.
This creates considerable uncertainty for the group’s sub debt and especially its hybrid capital securities, which could be in the firing line for loss absorption in case a more drastic solution is chosen by the regulators for SNS’ problems. Even in a more likely going concern scenario it seems that at least some losses might accrue to hybrid investors, e.g. through coupon losses or discounted tenders, etc. Senior secured as well as unsecured debt on the other hand should be less affected from any further restructuring steps, in line with EU practices so far.
CAPITAL STRUCTURE AND GOV’T REPAYMENT:
SNS required outside capital support in 2008 after the value of its investment portfolios in the insurance operations declined considerably at the time. Support came from the group’s majority owner Stichting Beheer SNS REAAL (Stichting - the trust which owns 50% of SNS Reaal’s ordinary shares) in the form of loss absorbing core tier 1 securities as well as nthe Dutch State through non-loss absorbing tier 1 securities. Separately, Stinchting had already injected “B” shares back in 2008.
Ordinary shares … the group’s market capitalisation is a very modest €296mn at the time of writing, well below book value (price / book according to Bloomberg was only 6%). While at least partially this is due to the existence of B shares (see below) and the high likelihood of strong dilution going forward it makes capital raising from the public equity market extremely costly if it is possible at all. Stichting would likely be stretched to maintain its majority ownership in the group.
B shares … issued in 2008 for a total nominal value of €600mn to Stichting. The B shares receive a dividend yield equivalent to 90% of that paid on ordinary shares, up to a dividend payout ratio of 45%.
Loss absorbing core tier 1 securities issued to Stichting … €500mn worth of these securities were originally issued and €435mn remain outstanding. The structure of these securities is somewhat complicated with various features intended to provide capital support on one hand, but prevent shareholder dilution for Stichting on the other hand. The securities pay interest of 6% p.a. if dividends on ordinary shares are paid. €103mn of the outstanding amount can be redeemed at par, while the remaining securities can be repurchased at 120% of par. The trust has conversion rights into ordinary shares in case ordinary shares are issued before the instruments have been repaid.
Securities issued to the Dutch State … The Dutch State injected €750mn core tier 1 securities into the group in 2008 of which €565mn remain outstanding. Payment is due if SNS pays a dividend and is either 8.5% or the dividend paid for ordinary shares multiplied by a factor of 1.25x (whichever is higher). Unpaid coupons are non-cumulative. The securities can be redeemed at a price of 150% of par or converted into ordinary shares at par, although the Dutch State in that case has the right to demand to be paid out in cash + accrued.
The restructuring plan agreed with the EU Commission contains a clause that SNS has to repay the Dutch State securities by the end of 2013 at the latest and based on the 150% redemption this means a payment of €847mn. The alternative option to convert the securities into shares seems to be out of reach on the other hand, since the conversion price was set at the time of issuance of the securities and is far above the current share price (i.e. it would be entirely un-economical for the government to convert).
Group capital resources on the other hand at mid-2012 were shareholders’ equity of €3.8bn and total capital resources of €4.8bn including holders of core tier 1 securities. After a loss from property finance in 3Q 2012, this was enough for a banking core tier 1 ratio of 8.8% (equivalent to €1.8bn of capital) and an insurance solvency ratio of 198% (regulatory capital of €2.8bn). These numbers compare to targets of 10% for the bank core tier 1 ratio and an insurance solvency ratio of better than 175%. While the insurance operations might be able to release some excess capital to the group, therefore, it seems unlikely that the full theoretical free excess can be used, since regulators will likely want to continue to see a certain buffer above the ratio target.
In any case, given the shortfall in the banking capital target, potential further provisioning needs for the property finance book (see below) and also a modestly over-stretched HoldCo double leverage (118.4% vs a max. target of 115%) it seems currently unlikely that the group will be able to squeeze enough excess capital out of its operations to (be allowed to) repay the government capital. It even seems likely that some additional capital resources are necessary to cover latent downside risks in the property finance portfolio.
Missing the end-2013 EU deadline for State capital repayment could ultimately lead to a renewed state aid investigation with potentially negative consequences for the group since renewed state aid requests could be interpreted as an indication of economic non-viability by the Commission (see WestLB or Dexia as precedents, although economically SNS seems to be in much better shape than these extreme examples and SNS may have some systemic importance in the Dutch market). Consequences could be significant also for subordinated and especially hybrid debt instruments.
Reflecting this pressure the group is currently exploring a range of potential measures in order to find a solution for this capital problem. Alternatives being investigated include, among other things (without further detail available from the company):
· sale of parts of the business,
· limitation of credit risks at Property Finance · issuance of ordinary shares, · conversion of core Tier 1 securities, · a reduction in the number of classes of shares, · reduction of double leverage).
It is likely that no single measure in itself will solve the group’s capital issues and indeed the company believes that a combination of these measures is likely, although many of these seem problematic for a variety of reasons. E.g. a capital increase is complicated due to the depressed market cap of SNS, which may partially be due to the existence of the B shares; property assets are on the book and limiting risk from this will not be easy, etc.
As far as non-core hybrid capital securities are concerned there seems to be a high likelihood that these will be drawn into the capital raising efforts of the group through a possible discounted tender, even though this option has not been explicitly mentioned by the group so far.
PROPERTY FINANCE:
One of the key problems of the group in recent years and main reason why it hasn’t been able to accumulate enough profit to repay the government capital as originally envisaged has been a portfolio of property finance activities which SNS acquired in 2006 from ABN Amro. With non-performing loans surging in this area these activities have been put in run-off with total exposures declining from €16bn at the beginning of 2009 to €8.3bn at the end of 3Q 2012. For some time SNS attempted to integrate some of these activities in its SME bank, but recently it reversed this attempt, placing all the related assets in run-off, for a total property finance run-off portfolio of €9.8bn. The remaining activities of the SME bank will be integrated into the retail bank.
Non-performing loans have continued to rise in this area with a total NPL amount of €2.3bn at the end of 3Q 2012 (24% of gross loans) and a coverage ratio of 38% of NPLs (approx. €880mn). Despite the progress made it looks likely that provisioning charges will remain high in this area of business and indeed recently the impairment charge has increased from a run-rate of around €70mn per quarter to €118mn in the third quarter of 2012. Some press reports suggest that the latent provisioning needs in the property portfolio remain substantial. E.g. most recently the bank was sued by a Spanish developer for damages of €400mn over a failed Spanish golf resort development.
KEY BONDS:
The two hybrid securities – SNSSNS 6.258 and 11.25 have somewhat unusual features (see below for details). Much of the coupon difference is reflected in the price of the two instruments, but arguably the cumulative coupon deferral feature (limited to five years, however!) arguably makes the 6.258 HoldCo bond the more attractive instrument.
Indeed if the two bonds are calculated to e.g. take-out dates in 2022 for the 6.258 and 2024 for the 11.25 it seems that the cumulative feature of the 6.258 is priced very cheaply, i.e. doesn’t seem to be fully reflected in prices. Having said that, all subordinated instruments of the SNS group carry high risks at this stage and uncertainties ahead of the next restructuring announcements (expected in February) are very high, suggesting caution or at best a small speculative involvement for the time being.
SNSSNS 6.258 p-17 (ISIN
XS0310904155)
Issued by the group HoldCo SNS REAAL NV as a deeply subordinated instrument, ranking below dated subordinated HoldCo debt, but ahead of all classes of share capital (of the group HoldCo) in a winding up.
Mandatory coupon deferral takes place if · the issuer will not be solvent on the payment date · a regulatory event has occurred, or · the Dutch Central Bank has requested a deferral
Separately there is a general option to defer coupons, although this is subject to both typical dividend pusher as well as stopper conditions.
Any deferral is cumulative (although with limitations – see further in this paragraph!) and in optional deferral bears interest at the respective applicable coupon rate. However, deferred coupons will be settled via an Alternative coupon Settlement Mechanism (ACSM, i.e. the issuance and sale of shares to satisfy the deferred amounts). Unusually, this is subject to a so-called Ordinary Shares Threshold, which means that no more than 2% of shares outstanding during any 12 month period prior to and after the deferral event can be issued to satisfy the outstanding coupons. Investors’ claim for deferred coupon settlement lapses if deferrals have not been settled within five years after the initial deferral event.
The coupon switches to 3M Euribor + 229bps in 2017, which is a 100bps step-up relative to the launch spread. While under forthcoming Basel III rules this bond would stop counting as Tier 1 capital the bond is HoldCo debt and not part of the bank’s tier 1 capital. A call is possible in 2017, but has to be considered unlikely for the time being. Yield to perpetuity at current market levels is approx. 10.9%, using the Bloomberg YASN pricing screen.
A regulatory call would take place at the higher of par or a make whole amount based on the govvy benchmark + 52 bps.
Extraordinary resolutions concerned with modifying any dates of payment of interest, reducing or cancelling the amount of principal or the rate of interest payable or altering the currency of payment require a quorum of at least one third of the nominal amount of the securities and it appears that the vote is decided by simple majority (in other words – to block such an alteration one needs to control at least 50% of the notes).
SNSSNS 11.25 p-19 (ISIN
XS0468954523)
Tier 1 notes issued by SNS Bank NV, the bank OpCo of the group. Interest rate on the bond resets at the first call date to the 5 year Euro Swap Rate + 775.5 bps initial credit spread + 200 bps additional step-up. Deeply subordinated, but rank ahead of all classes of share capital of the issuer (the bank) in a winding up.
Mandatory coupon deferral takes place if · the issuer will not be solvent on the payment date · a regulatory event has occurred, or · the Dutch Central Bank has requested a deferral
Separately there is an optional coupon deferral clause, subject to typical dividend pusher and stopper clauses.
Unlike the SNSSNS 6.258 bond above, however, for the SNSSNS 11.25 coupon deferral is non-cumulative, i.e. any unpaid coupons would be immediately lost for investors. Given the possibility of EU restrictions on coupon payments going forward under a re-negotiation of existing state aid, this is a significant risk factor for this bond. In many other cases the EU Commission has requested coupon skips for at least two years as a result of state aid and possibly longer until state aid is repaid.
Unusually, the bond has a so-called Conditional Call Exercise Date on 27 November 2024, which means that if the bank is required to pay coupons (e.g. due to a dividend pusher event) and has raised sufficient replacement capital until that time it is required to redeem the instrument at that date or at any subsequent coupon date if the conditions are met by then. It will use commercially reasonable efforts to raise the replacement capital. There is therefore a higher likelihood of redemption for this bond in 2024 at least in a going concern scenario than would be the case for other hybrid securities, although the conditional call would not apply in a stress situation for the bank.
An earlier regulatory call would take place at the higher of par or a make whole amount based on the Bund benchmark + 250 bps.
Lastly there is a somewhat confusing substitution clause in the programme prospectus which seems to allow the substitution of the issuer by the group holding or any subsidiary of the bank or the group. It seems like payments under the Tier 1 notes would continue to be guaranteed by SNS Bank on a subordinated basis in this scenario, but this is not entirely clear and it could be that no such guarantee applies in all circumstances.
SNSSNS 9 2041-21 (ISIN
XS0616936372)
Solvency II compliant Tier 2 notes (i.e. fairly deeply subordinated) of SRLEV NV, which is a 100% subsidiary of REAAL NV and an OpCo insurance of the SNS REAAL group. REAAL NV co-guarantees the contractual obligations arising from the notes on a deeply subordinated basis, but doesn’t guarantee payments as such (a so-called 403-guarantee under Dutch law).
The bond matures in 2041, but only to the extent that no capital adequacy breach has occurred at the time, i.e. maturity can be extended beyond the final maturity date in such a case (this is a typical feature of newer style insurance Tier 2 capital). There is an optional early call from 2021 and at any coupon date thereafter, although such redemption requires regulatory approval. Coupon is fixed at 9% p.a. to the first call date, when it switches to 12M Euribor + 616.5bps, which is a step-up of 100bps compared to the launch spread. The call signal this step-up may contain is reduced by the requirement of regulatory approval for an early call. At the time of writing the bond trades wider than the post-call stepped up spread and the likelihood of a call for the bond considering the current circumstances of the group would be small if they persisted until the first call date.
Apart from the normal 2041-21 call structure, the bond has regulatory, tax, as well as rating agency calls at par, i.e. there is no make-whole clause in such events.
Coupon payment is optional, subject to a dividend pusher for the six months period prior to the coupon payment date. Any coupon deferral is cumulative.
This bond currently trades with a noticeable discount to other insurance Tier 2 bonds, but it remains to be seen to what extent it might get included in SNS’s capital raising efforts or to what extent the EU Commission might impact its performance in case of further restructuring requirements.
SNSSNS 7 p-16 in CHF (ISIN
CH0130249581) Relatively small bond with CHF 105mn outstanding. Deeply subordinated perpetual bond of SRLEV NV again covered by a 403 guarantee of REAAL as the SNSSNS 9% 2041-21. The bond has an optional redemption clause from December 2016. If not called, the coupon switches to the 5 year CHF Mid Swap Rate + 562.5bps, which I believe makes this bond a “non-step” perp.
Coupons can be optionally deferred, subject to a dividend stopper, but must be mandatorily deferred in a breach of capital adequacy requirements. Deferred coupons are cumulative and accrue interest on the deferred interest.
Again the bond has regulatory, tax, as well as rating agency calls at par, i.e. there is no make-whole clause in such events
