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2.1 Equity capital
The ECB has announced it will allow banks 6 months to cover capital shortfalls identified in the AQR or baseline stress test scenario using Common Equity Tier 1 (“CET1”), being equity share capital and retained earnings. A bank raising equity share capital will need to ensure it can meet this deadline bearing in mind that regulatory and market factors may limit the windows for successful capital issuance.
The optimal market windows typically avoid holiday periods, such as Christmas and Thanksgiving in late November, and are driven by the requirement for any prospectus for the issue to contain up-to-date audited or auditor-reviewed financial information. An issue may be delayed until this information is available. If the securities are to be offered to US investors, there may be pressure to effect the issue within 135 days of the end of the most recent period for which there has been an audit or auditors’ review. This is because the auditors’ comfort, under US accounting standards, will be weaker if given after the 135 day limit, increasing risk from the underwriters’ perspective. The best market windows for a bank to issue new securities after the anticipated October 2014 publication of the comprehensive assessment results may therefore be by mid-November 2014, if based on 2014 half-yearly information, or shortly after the bank’s 2014 annual accounts are published.
Whether a bank can access the markets in one of these windows will depend in part on its readiness. Early preparation is key, including appointing advisers and analysing legal/structuring points likely to impact the timing and success of the issue. These points are summarised in box 3 and discussed below.
The starting point is to check whether a prospectus is required. This will be necessary if a new class of securities is to be admitted to trading on a regulated market or, if the new securities are part of an already listed class, they number 10% or more of those already issued over any 12 month period. A prospectus will also be required for issues offered to retail investors.
Prospectus disclosure requirements are extensive. An issuer and its directors are liable for the prospectus content. The bank will need to ensure the prospectus is prepared with care and adequate due diligence is done to support disclosure, protect against liability and satisfy any underwriters’ diligence requirements.
The prospectus must contain the information necessary to enable investors to make an informed assessment of the issuer’s financial position and prospects. This will require detailed consideration and disclosure of issues raised in the comprehensive assessment. The issuing bank must also confirm in the prospectus that it has sufficient working capital for at least the next 12 months, a statement tested against reasonable assumptions. Inability to make a clean working capital statement may be a significant barrier to
> Deadline for announcing capital raising
> Amount of capital to be raised
> Date of issuing bank’s most recent financial information
> Level of certainty as to capital raising required on announcement
> New securities – new class or already listed class
> New securities – whether to be admitted to trading on a regulated market
> Issuing bank’s ability to make a clean working capital statement in prospectus
> Directors’ authority to issue securities – possible shareholder approval
> Pre-emption rights – possible shareholder approval to disapply
> Identity of investors – any cornerstone investors
Box 3: Raising equity capital: key legal/structuring points
2 Balance sheet strengthening by bank
5 Restoring confidence. The changing European banking landscape
Extensive recent equity capital raising by Eurozone banks highlights this option as a key tool for banks to strengthen their balance sheets. Its availability depends on a wide range of factors.
Claudia Parzani Partner – Capital MarketsLinklaters – Italy
accessing the markets. Assessing a bank’s liquidity requirements over a period in excess of 12 months in various risk scenarios is complex, and potentially more challenging given possible market volatility linked to the comprehensive assessment.
Initial drafting of the prospectus is likely to take time, requiring a fresh document or extensive updates to a shelf registration statement or recently-issued prospectus in light of the comprehensive assessment. The prospectus will be submitted to the relevant competent authority for approval, which typically takes at least 4 weeks.
Shareholder approval at a general meeting will be required for any new equity issue to the extent the directors do not have standing powers to issue equity securities. Existing shareholders’ pre-emption rights to subscribe for the new securities may have been disapplied, but such disapplications are typically limited (see box 4). Any issue beyond that limit will require shareholder approval at a general meeting or need to be made on a pre-emptive basis, typically providing a minimum 2 week period for acceptance. The notice period required for a general meeting varies across jurisdictions (see box 4) and may be up to 4-6 weeks.
These factors mean larger equity capital issues are typically subject to more legal/regulatory requirements, with many recent bank capital raisings requiring a prospectus and shareholder approvals. This results in a longer timetable. Although timetables can vary considerably across jurisdictions (see box 4), a large rights issue may take 2-6 months from initial preparation to completion.
Underwriting is particularly important for rights issues in potentially volatile markets where certainty of funds is needed. A bank raising capital as a result of the comprehensive assessment will need such certainty, to give investors confidence in its financial condition and underpin its working capital statement. This may result in the bank seeking an early underwriting commitment, some time before the issue is ready to be launched. Given the uncertainties involved, underwriters are unlikely to offer a standard underwriting commitment at an acceptable share price. Instead, a “standby” underwriting commitment, whether a comfort letter, a “soft” commitment subject to conditions such as underwriters’ satisfaction following due diligence or a “hard” commitment subject to typical equity underwriting agreement conditions, may be desirable to assure the issuing bank of its ability to complete a capital raising.
Strategic investors may seek to acquire a significant stake in a bank by subscribing for new equity instead of or alongside a pre-emptive issue, providing cornerstone investment. This can help an issue to succeed, with the cornerstone investor boosting market confidence and reducing the amount needed from other investors. For example, in 2014 Deutsche Bank raised €8.5bn through a €6.75bn rights issue and separate €1.75bn placing with a cornerstone investor, and in the 2013 €1.4bn equity raising by Spain’s Banco Sabadell, two cornerstone investors purchased €425m of the accelerated book-build shares and agreed to exercise their subscription rights corresponding to those shares in the accompanying rights issue. However, a cornerstone
investor may attach conditions to its investment, potentially even terminating in circumstances where underwriting banks and existing shareholders may support the issuer, as occurred in the 2008 rights issue by UK bank Bradford & Bingley.
Investors more generally will also look for strong governance and a robust approach to directorships to be in place in the bank. Equally important is the transparency of the bank’s balance sheet, to identify its core and non-core businesses, and so its true capital position and profit-making activities.
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Approx. prospectus preparation period
GM notice period (if required)
Approx. offer period Maximum size of issue
2-3 weeks2 35 days3 RI: 21-30 days
PO:15-20 days
PP: 5 days
PP: 20% of issued capital p.a. (12 month rolling)
All others: as per GM resolution
6-12 weeks 30 days4 RI: 21 days
PP: 3-5 days
No limit if direct GM authority; 50% of issued capital if from authorised capital (reduced to 10% if with SEPR)
30 days2 30 days5 RI: 15 business days6
PO: 15-20 days
PP: 5 days
PO/PP: 10% of issued capital if shares issued at market value (SEPR)
All others: as per GM resolution
4-5 weeks7 1 month8 RI: 45 days
PO: 40 days
PP: 5 days
No limit if agreed/executed by GM. If delegated ≤50% of share capital
France
Germany
Italy
Spain
1. Assumes issuer is a listed bank
2. Based on existing disclosure
3. Includes minimum 15 day final notice period
4. Add 7 days if shareholders must register
5. Capital increases must be authorised by the Bank of Italy.
Assumes this is authorised during notice period, not 90 day
statutory period
6. Add up to 5 business days for auction of unexercised rights
7. From first filing of a complete prospectus with regulator.
Capital increases must be authorised by the Bank of Spain
8. Unless extended by articles of association or shortened
if shareholders can vote electronically
Key:RI: Rights issuePO: Non pre-emptive public offerPP: Non pre-emptive private placementSEPR: Simplified exclusion of pre-emption rights
Box 4: Equity capital raising: cross-border legal requirements1
7 Restoring confidence. The changing European banking landscape
Box 5: Additional Tier 1 and Coco Tier 2 issuance – regulatory capital classification, 2010-2014
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
0
2
4
6
8
10
12
14
16
2010 2011 2012 2013 H1 2014
Unspecified Tier 2 Additional Tier 1 Deal count
Box 5: Additional Tier 1 and Coco Tier 2 issuance - regulatorycapital classification, 2010 -2014
Prin
cipa
l am
ount
issu
ed (
€M)
Dea
l cou
nt
Source: Dealogic. Includes issuance for banks from Austria, Belgium, Cyprus, Estonia, Finland,
France, Germany, Greece, Ireland, Italy, Luxembourg, Latvia, Malta, Netherlands, Portugal,
Slovenia, Slovakia, Spain, UK
Box 6: Additional Tier 1 and Coco Tier 2 issuance - investor base, H1 2014 by share of principal amount
Asset management
Hedge fund
Fund managers
Private banks
Insurance /FI / pension funds
Others
Other banks
Source: Dealogic. Sample of
deals from European banks
for a total principal amount
of €5.6bn
2.2 Additional tier 1 capital
The ECB has announced it will allow banks 9 months to cover capital shortfalls identified in the adverse stress test scenario using Additional Tier 1 (“AT1”) capital up to specified limits. A bank may therefore consider whether it is appropriate to issue AT1 capital as an alternative to, or to complement, a rights issue or equity placing.
AT1 is intended to form the highest quality, most loss absorbing, capital after CET1. AT1 is deeply subordinated capital which converts into equity or is written down upon specified trigger events occurring. Payments on AT1 capital are at best discretionary and non-cumulative, without any contractual consequences for the issuer or other investor protections if payment is not made.
Despite forming a new and untested asset class, investor demand for AT1 was strong through the first half of 2014 (see box 5). Banks will hope to maintain such demand from existing investor classes (see box 6), while seeking to extend the investor base for these relatively high yielding instruments where investment mandates can be extended to cover AT1. However, AT1 issuing banks have typically tended to do so from a position of relative strength, for example to replace existing capital or shore up an already robust leverage ratio. A bank considering raising AT1 capital in response to the comprehensive assessment results may face more difficulties and potential market volatility. Focus on investors’ typical two main concerns is therefore key.
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> Optimal issuing entity for bail-in
> Preferred structure – contingent conversion or write-down
> Write-down – permanent or temporary, full or partial
> Contingent conversion – shareholder approval requirements
> Appropriate CET1 capital ratio trigger – 5.125%, 5.5%, 7%
> Bank investability – interest non-payment risk
> Affordability for issuing bank
> Tax and accounting issues
> Listing requirements
> Identity of investors
Box 7: Raising AT1 capital: key structuring points
First, AT1 capital must convert into equity or be written down upon breach of a specified CET1 capital ratio. CRD4 specifies a minimum trigger of 5.125%, but envisages this may be higher. A number of banks have set a 7% trigger for debut AT1 issuances and the adverse stress test scenario sets a hurdle rate of 5.5%. Investors will only invest in AT1 securities if they are confident the issuing bank is, and is expected to remain, comfortably above the specified trigger point for conversion or write-down. In some circumstances, it may therefore be necessary to raise or retain CET1 before investors are willing to buy AT1.
Second, AT1 capital must provide for cancellation of interest, on a discretionary basis and mandatorily where an issuer does not have sufficient distributable reserves to cover interest payments. Investors would not normally expect even a struggling bank to use its discretion to cancel interest payments where it has other options. A regulator could, however, direct the bank to do so in circumstances where the directors would prefer not to. Investors cannot easily price in interest non-payment risk and may decide not to invest unless they perceive the likelihood of non-payment to be remote.
It will also be important to investors for strong governance and balance sheet transparency to be addressed by the bank.
Banks able to address these issues and attract prospective AT1 investors should consider various key structuring points at an early stage. These are summarised in box 7 and discussed below.
The first consideration is whether the issuer should be the bank or its ultimate parent. CRD4 permits both structures. The BRRD also permits both “single point of entry” structures, where publicly-held capital is issued and bailed in at the banking group parent level, and “multiple points of entry” structures, where publicly-held capital is issued and bailed in at the bank level. However, national regulators may express a preference for either structure and this, together with any other structuring and execution concerns of the regulator, should be taken into account. If conversion were to occur, investors, and existing shareholders, may wish the resulting shares to be issued out of the more liquid, listed holding company rather than causing dilution at the unlisted bank level.
9 Restoring confidence. The changing European banking landscape
Additional Tier 1 capital is emerging as a new asset class. With strong investor demand to date but potentially volatile markets, it is essential to focus on key structuring issues.
António Soares Partner – Corporate FinanceLinklaters – Portugal
The most appropriate loss absorption mechanism – conversion or write-down – must be considered. This may involve a conflict between satisfying the needs of AT1 investors and those of existing shareholders. Equity conversion instruments tend to require shareholder approval. If such approval can be obtained, investors may prefer contingent conversion instruments given that they share in any potential “equity upside”, whereas shareholders may dislike the potential dilution. Some recent bank issuers have included a discretion upon conversion to effect a quasi pre-emptive offering to existing shareholders, with only the cash proceeds of sale delivered to bond investors. Where a write-down structure is appropriate, investors typically prefer temporary write-down to permanent write-down securities, and partial write-down structures to full write off. The more AT1 investor-friendly approaches may lead to better pricing or investor take-up. However, shareholders may prefer the issue of permanent and full write-down instruments as these effectively invert the bank’s traditional capital structure in their favour.
Shareholder approvals aside, issuing AT1 may take less time than an equity share capital issue where a prospectus is prepared. A typical AT1 issue will take 6-8 weeks, subject to obtaining any necessary approvals from the local tax authorities and prudential supervisor.
Regulators may focus on interest payments (albeit discretionary) not being set at a cost above that considered supportable by the issuing bank.
The tax treatment of AT1 securities has only been settled in a small number of countries to date and it will be necessary to check the tax position carefully. Issues to consider include the deductibility of interest payments, any tax de-grouping risk if conversion shares are not issued at the banking group parent level and any taxable profit/gain on which the regulator will require a day 1 capital deduction.
The bank should consider how the AT1 securities will be characterised for accounting purposes. This includes whether they will be fully accounted for as equity, whether debt accounting is possible and whether the proposed structure causes any accounting tensions, for example because of embedded derivatives or cross-currency related swaps that might cause P&L volatility.
Some national regulators have voiced concerns that investors, particularly retail investors, are not well placed to gauge the likelihood of loss absorption occurring. They may therefore be unwilling to see AT1 securities placed with retail investors going forward.
Most investors will require AT1 securities to be listed to meet their investment mandates. Banks have tended to list contingent convertible AT1 securities as debt securities on exchange-regulated markets, such as GEM in Ireland or the SIX in Switzerland. This avoids the additional work and time required to produce an equity-style prospectus to list contingent convertible AT1 securities that convert into equity on an EEA regulated market.
A potentially significant structuring consideration will be the availability of Rule 144A under the US Securities Act of 1933 for transactions involving the offer and sale of AT1 capital securities to institutional investors in the United States without registration with the US Securities and Exchange Commission (the “SEC”). For an issuer which has shares or depositary receipts publicly listed or quoted in the United States and thus is a SEC reporting company, Rule 144A may not be used for offerings of contingent convertible AT1 securities. A number of such issuers have structured such offerings as SEC-registered offerings, particularly where the issuer has an effective SEC shelf registration which can be used. Non-SEC-reporting companies should be able to use Rule 144A for a registration-exempt offering of contingent convertible securities. The technical issue does not arise with respect to write-down securities without an equity conversion component.
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Box 8: Primary types of liability management
Exchange offer Issuer approaches holders to exchange outstanding securities for an issue of new securities by the issuer/another entity on a voluntary basis.
May be combined with a consent solicitation to effect early mandatory redemption of those securities not submitted for exchange by holders.
Tender offer Issuer approaches holders to buy back outstanding securities for cash on a voluntary basis.
May be combined with a consent solicitation to effect early mandatory redemption of those securities not submitted for purchase by holders.
Consent solicitation Issuer requests consent from requisite threshold of holders of a series of debt securities to amend the terms and conditions of the whole series of those securities.
Liability management exercises may offer advantages over “new money” capital transactions, including the potential to retire, replace or amend inefficient capital and to improve the overall quality of a group’s existing capital structure.
Carson Welsh Partner – Capital MarketsLinklaters – UK
2.3 Liability management
A bank anticipating challenges in accessing new investors to subscribe for securities, or preferring not to approach new investors, may consider targeting existing capital securities which it has issued as an alternative option. Under the appropriate type of liability management transaction, a bank may buy back, exchange or amend the terms of its existing securities (see box 8). Many banks across Europe have used such transactions to
achieve different capital benefits, and a bank should consider whether any of these may be best suited to its circumstances.
Exchange offers provide an opportunity to replace capital of a lower quality, or which no longer provides a significant/any capital benefit, with capital of a higher quality, as achieved by Eurobank Ergasias in 2013 when Tier 2 debt instruments were exchanged for equity. Banks may also take advantage of circumstances where capital instruments are trading at prices
below par, generating a profit/CET1 gain. Under an exchange offer the issuer may be changed, which will be particularly relevant if “single point of entry” requirements are imposed by a regulator. Voluntary bail-in of existing capital instruments (when combined with a consent solicitation as described below) is possible under an exchange offer, as is reducing interest expense by retiring higher interest rate bearing securities at a time when new lower coupon securities can be issued.
11 Restoring confidence. The changing European banking landscape
Tender offers may be used for some of these purposes. For example, a tender offer may be used to take advantage of circumstances where capital instruments are trading at prices below par, generating a profit/CET1 gain, as achieved by Attica Bank and Alpha Bank in Greece in their 2013 offers. A tender offer may also be used to retire (without calling) capital instruments, which may be advantageous where the bank has a surplus of such instruments in issue, and to reduce interest expense by retiring higher interest rate bearing existing securities.
Consent solicitations offer different advantages. A consent solicitation may seek to amend securities to bring terms in line with new regulatory requirements or improve their capital quality. Alternatively, this technique may provide, in conjunction with a tender offer and/or exchange offer, for bonds to be amended by inserting a call option. This can be used to ensure that if relevant voting thresholds are met, securities which were not voluntarily offered for exchange or purchase by the holders can be mandatorily redeemed.
Banks wishing to conduct a liability management transaction should consider various key structuring points. These are summarised in box 9 and discussed below.
The first consideration is whether the bank’s capital structure contains restrictions which could inhibit liability management. For example, there may be active “dividend stoppers” in the bank’s capital instruments, prohibiting repurchase or optional redemption of other parity or junior obligations as a result of non-payment on discretionary-pay capital instruments.
> Transaction type – exchange offer, tender offer or consent solicitation
> Intended capital benefit
> Possible restrictions in capital structure
> Contractual terms of existing securities
> Jurisdictional restrictions
> Hedge fund investors
> Retail investors
> US investors
> Disclosure requirements
> Voluntary or mandatory offer – pricing issues
Box 9: Liability management: key structuring points
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Unlike in a new issue of securities, the holders of existing securities are a pre-existing group and issuing banks should be aware of jurisdictional securities law restrictions that may apply to making offers to them. This can lead to a range of consequences, from requiring restrictions to be included in offer documents to excluding holders in those jurisdictions from participation.
Where an issuer is perceived to be in financial difficulty, there has been a trend of seeing increased hedge fund holdings in the issuer’s capital instruments. These funds may be looking to benefit from the increased yields on the instruments if they are trading at a discount and may also be able to leverage their joint position to negotiate a more advantageous deal in any restructuring if they hold what they perceive to be a blocking stake.
Retail holders may also voice concerns that they do not wish to exit their investments due to the income stream provided by their securities and may argue they are owed a duty to be insulated from any participation in the underlying transaction. Their ability to attract publicity has led to concerns over inversion of capital structures where the most subordinated securities are in retail hands. Where a bank has retail investors it will also need to consider any exit strategy for such investors, for example a cash tender offer may be appropriate if they cannot be offered new securities as a result of regulators’ concerns about retail holders not being well placed to receive complex instruments.
Unlike a rights issue, there are no specific timing requirements in relation to the period for an exchange offer or tender offer to be left open. However, if an offer is to be made into the US, significant timetable consequences are likely and so some issuers simply choose to exclude US holders in a voluntary offer. The timing of a consent solicitation is governed by the terms of the underlying securities.
Where new securities are being issued, disclosure can be a significant issue if the issuing bank is in distress or a rapidly changing position. This will become more acute if the securities are to be listed and a prospectus is required.
Tender offers and exchange offers are by their nature voluntary. If a holder does not wish to participate, it may remain a holder of the security. However, both types of offer can be made mandatory by combining them with a consent solicitation. The question of pricing in such combined transactions has come into sharper focus from an English law perspective in light of recent case law condemning a resolution where the purchase price for securities purchased from those participating voluntarily was significantly greater than that provided to those being redeemed by means of the consent. Although the circumstances in that case involved a very stark difference in voluntary/mandatory prices, it has raised questions about the level of incentive that can be given by way of premium in a consent to voluntarily participating holders.
13 Restoring confidence. The changing European banking landscape
Box 10: Loan portfolio sales: licensing/security transfer requirements
Undrawn loans/RCFs – licence required?1
Drawn loans – licence required?1
Transfer of security agent – required formalities/restrictions on transferee?
Transfer of security interests – required formalities/restrictions on transferee?
• Notifications, registrations and other formalities required
• Possible licence required for transferee
• Security granted in favour of individual lenders or to security agent as parallel debt creditor
• Notifications, registrations and other formalities required
• Certain security interests can only be held by certain financial institutions
2
• No formalities typically required
• No restrictions on transferee
• Security typically granted in favour of security agent as parallel debt creditor
• Consents may be required if not included in documentation
• Notarisations, registrations and other formalities may be required
• Retaking of security may be required
• Consents may be required if not included in documentation
• Notifications, registrations and other formalities required; significant taxes may be payable
• Security granted in favour of individual lenders; powers of attorney required for security agent to administer security on behalf of lenders
• Notifications, registrations and other formalities required; significant taxes may be payable
• Certain security interests can only be held by certain financial institutions
• Notarial public deed of transfer required to ratify security (whether held by security agent or by individual lenders)
• Security typically granted in favour of individual lenders, although security agent may hold security on behalf of all lenders with powers of attorney for enforcement
• Notarisations required
• Registrations and other formalities may be required, depending on the type of security
France
Germany
Italy
Spain
1. Exemptions from licence requirements, for undrawn and drawn loans, may be available in particular
jurisdictions and should be considered on a case by case basis.
2. A licence may be required for a transfer which is not simply an assignment and in certain other circumstances.
A bidder’s ability to access post-sale loans servicing, whether in-house or third party, has emerged as a key issue for success on Spanish loan portfolio sales.
Victor Manchado Partner – CorporateLinklaters – Spain
2.4 Loan portfolio sales
Deleveraging by disposing of loan portfolios is an option used extensively by banks in some jurisdictions. With deleveraging in those jurisdictions set to continue, the availability of this route for banks in other jurisdictions will depend on a variety of factors.
The first step is to identify the pool of loans to be sold and then the potential bidders and any limitations to which they may be subject. Where jurisdictions do not restrict lending to a licensed bank and do not require a purchaser of loans to hold a licence (see box 10), this greatly facilitates the sale of loan portfolios, broadening the universe of bidders and simplifying the transaction. In any jurisdiction which does have licensing requirements, either an already-licensed bidder may be preferred or the practical implications of a bidder obtaining a licence, including completing a potentially complex approval process, will need to be taken into account.
Complexities which may affect the transaction timetable or pricing should be identified early. Transferring any security in relation to the loans, and any security agency or other role which the selling bank may wish to transfer, may raise significant timing or cost issues (see box 10). If hedging is associated with any loan, the selling bank will need to consider any potential hedge mis-selling issues, the bidders’ willingness/ability to purchase the hedging and any consequent need to separate the loan and hedge. This typically generates significant work for the selling bank and may require it to enter into an intercreditor agreement with the bidder and close-out or transfer the selling bank’s associated market swaps.
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Each jurisdiction’s legal regime strongly influences the key stages of a loan portfolio sale – from a bidder’s licensing requirements to mechanisms for transferring the portfolio and tools for enforcement action.
Francesco Faldi Partner – Banking and ProjectsLinklaters – Italy
The selling bank should consider how the loans will be serviced post sale. A bidder may have its own servicing capability or may use a third party servicer. A bidder unable to access loans servicing capability will be at a disadvantage, as this will impact its deliverability of the transaction and likely pricing, and may therefore be less credible.
Separately, the selling bank may also consider selling its own servicing platform (typically comprising debt recovery, mortgage foreclosure, real estate management and sales), if it has not already done so, to financial investors in consideration for a significant up-front payment. While the selling bank may retain a non-controlling stake in the servicer, separating the servicing platform from the remainder of the bank will be key.
Various key structuring points should also be considered at an early stage by the selling bank to ensure the transaction’s success. These are summarised in box 11 and discussed below.
First, the loan assets to be sold should be identified and information about the portfolio assembled. The selling bank will typically create a data tape containing key information about the loans. The data tape’s quality is crucial as investors will typically expect the selling bank to provide comfort in relation to that information. Original documentation relating to the portfolio should also be collected at this stage. Where such documentation is a condition to enforcing the relevant loan or security, it will be important for the buyer to obtain this.
> Types of loans – bilateral/syndicated, performing/non-performing
> Identity of bidders – jurisdictional licensing requirements
> Loans servicing – bidder capability or third party servicer
> Information about loan assets for data tape
> Original documentation relating to portfolio
> Content of any vendor due diligence pack
> Security interests/security agency role – jurisdictional transfer requirements
> Data protection, bank secrecy legislation, contractual confidentiality provisions
> Hedging issues – mis-selling, bidder’s ability to purchase, ability to separate
> Appropriate transaction structure
Box 11: Loan portfolio sales: key structuring points
Preparing a high level vendor due diligence pack for bidders can be a useful tool to identify issues in the portfolio and assist their focus on material matters for each loan. This can lead to a better-informed and more competitive bid process. For example, on the 2014 €20bn commercial real estate and residential mortgage loan disposals by IBRC’s Special Liquidator, vendor due diligence was made available to assist in meeting the strict timetable for the process.
Before the selling bank can disclose information, it should consider the impact of any data protection and bank secrecy legislation and contractual confidentiality provisions. This may restrict the information provided to bidders, including by requiring some information to be redacted from the data tape. With criminal penalties for breach of bank secrecy legislation in some jurisdictions, compliance with legislative requirements will be particularly important.
The selling bank should prepare for and resource each stage of the transaction appropriately. Box 12 shows the key stages typically seen in a competitive process.
The teaser stage seeks to market the portfolio to potential bidders using a high level information memorandum about the loan assets. A typical sale aims to invite 10-12 bidders into bid phase 1. While the top 5 investors in this market currently account for over 83% of all loan portfolio deals, many new entrants are keen to be involved. Selling banks or their advisers should engage with potential bidders as soon as possible to establish their commitment and ability to complete.
15 Restoring confidence. The changing European banking landscape
Box 12: Loan portfolio sale: typical timeline
The most appropriate transaction structure must be chosen at an early stage (see box 14). While this will typically be an outright sale, alternative structures may also be used, either as an interim step before effecting an outright sale or as a fall-back step if this becomes impossible. Occasionally it may be necessary to use an alternative structure as a permanent arrangement to address particular legal/contractual requirements.
In bid phase 1, bidders are typically given limited data room access to key information such as bidder pricing and assumptions templates, the data tape, information memorandum and possibly
also valuations on a loan by loan basis. Bidders are asked to submit an indicative bid and specify certain information such as internal/external approvals required, means of financing, servicing and portfolio transfer capabilities for the bid.
In bid phase 2, full due diligence is undertaken. Bidders are asked to produce a final bid, with information similar to that requested in bid phase 1, and a mark-up of transaction documentation including transfer documents.
The final phase typically starts with a short period to signing with one or more preferred bidders. A roadmap for
transferring each, or at least a majority, of the loans is likely to be agreed prior to signing to minimise disputes. After signing, the necessary third party consents and approvals are obtained, with closing taking place on a one-off or staggered basis. Post closing migration will then be key. Where the portfolio includes performing loans, the selling bank will typically need to focus on IT migration issues similar to those on a business sale, whereas its focus in relation to non-performing loans will typically be the transfer of any servicing capability for those loans.
Teaser Bid phase 1 Bid phase 2 Signing to completion
• Prepare high level information memorandum
• Invite bidders into bid phase 1
• Give bidders access to key information in data room
• Bidders to submit indicative bids
• Bidders undertake full due diligence
• Bidders to submit final bids
• Signing with preferred bidder(s)
• Agree roadmap for transfer
• Final completion
Key stages
Key actions
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2.5 Business sales
Business sales are a key option for a bank seeking to strengthen its balance sheet, restructure its businesses or focus on strategic goals and business plans.
Regulatory developments in the banking sector, such as the US introduction of the Volcker rule, the proposed European structural reforms following the Liikanen report and the implementation of the UK’s Vickers/Independent Commission on Banking recommendations, may drive some business sales. Other disposals may be mandated by the ECB or relevant authorities, or be part of a wider strategic aim. Sector consolidation may also be appropriate, to achieve merger synergies and economies of scale.
When launching a sale process, the selling bank will need to identify the universe of bidders for the disposal assets. Prospective purchasers may include existing participants in the banking sector, such as other banks, and private equity firms wishing to enter the market directly, for example by acquiring a bank, or work alongside servicers to gain exposure to banking businesses. The bidders will themselves face potential challenges such as regulatory capital and licensing requirements, and the selling bank should bear these challenges in mind as potential factors limiting credible buyers.
As highlighted in box 13, the regulatory analysis, transfer mechanisms, risk profile and timing will together determine deal structure. Identifying and understanding the sale assets will lead to a more efficient process.
> Non-core business – performing, non-performing, overseas businesses or other business lines
> Prospective purchasers – other banks, private equity, servicing platforms
> Available structures – share sale, business sale, asset sale, synthetic structure
> Licensing requirements – scope of business, change of control approvals
> Other conditions – anti-trust
> Regulatory capital impact of disposal
> Separation – transitional servicing arrangements, shared data/branding/security
> Ongoing engagement with regulators
> Conduct issues – risk allocation and ongoing management of complaints/remediation
> Customer communications plan
Box 13: Business sales: key structuring points
Choosing the appropriate transfer method for the business is key to delivering a deal, and box 14 identifies the principal methods available to banks for business divestments. This will be particularly important if there are any restrictions on transferring assets to a third party, for example where customer consents may be required. The extent of diligence required to verify this will vary, based on whether the business comprises standard form agreements (i.e. retail businesses) or bespoke contracts. As in relation to loan portfolio sales, more than one transfer method may be used on a transaction, depending on the techniques available. For example, on The Royal Bank of Scotland’s 2014 sale of its investor products and equity derivatives business to BNP Paribas, risk management of, and market making for, up to £15 billion of liabilities will be transferred, including by statutory transfer schemes where available.
The selling bank and buyer will need to engage with regulators and be mindful of requirements for licences, change of control approvals or notifications and their impact on the overall transaction timetable. This may mean staggered closings of transactions over a period of years, as seen on the 2012 acquisition by Julius Baer of the non-US wealth management business of Bank of America Merrill Lynch.
A key accompanying driver for banking sector M&A activity is likely to be managing regulatory capital requirements. The selling bank will need to assess the transaction’s impact on its regulatory capital position and bidders will want to understand the regulatory capital required to be held in connection with the acquired business and how that affects its pricing and business models.
17 Restoring confidence. The changing European banking landscape
Box 14: M&A transfer mechanisms
Sub-participation • Mainly used for loan portfolio sales.
• Risk or funded sub-participation.
• Transfers economic risks/benefits whilst leaving legal title with selling bank.
Swap-based structures • May use back-to-back swaps, total return swaps or declarations of trust.
Synthetic structures • May use static pool true sale CLOs, managed CLOs or covered bonds.
Outright sale • Transfers assets/liabilities by assignment and/or novation.
• May effect transfers directly (seller to buyer) or indirectly (seller hive-down to SPV followed by share sale of SPV to buyer).
• Bespoke SPA or, for loan portfolio sales, market secondary trading documents.
Statutory transfer mechanisms (schemes)
• May be available under local law (e.g. Article 58 transfers in Italy, Part VII FSMA transfers in UK).
• May not be recognised by other jurisdictions.
• Court processes may impact transaction timetable.
Cross-border mergers • May be used for business sales only.
• Merges businesses in different EU member states into a single entity, without individual novation process.
• Often used for intra-group reorganisations (e.g. The Royal Bank of Scotland’s merger of its overseas businesses following acquisition of ABN AMRO N.V.).
• Court process will impact transaction timetable.
Bespoke legislation • May be used for business sales only.
• Commonly seen in recovery scenarios or where statutory transfer mechanisms are not available or inadequate.
• Legislative process will impact transaction timetable.
Factors including bank structural regulatory developments, managing regulatory capital requirements and sector consolidation drive bank sector M&A. These overlay a bank’s focus on its strategic goals and core business.
Alain Garnier Partner – CorporateLinklaters – France
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Separating sale assets from the retained bank may be a significant challenge, impacting a transaction’s costs, timetable and documentation. Complex operational separation issues must be addressed for the transaction to succeed.
Matthew Bland Partner – CorporateLinklaters – UK
Perhaps the most significant challenge likely to be faced by a selling bank is the question of how to separate sale assets from the wider group. Often the major separation hurdle will be identifying the IT systems and services required to run the business, what needs to be transferred or provided with the transferring business and which services retained by the selling bank may need to continue to be provided to the purchaser under a servicing arrangement on a temporary or longer-term basis following completion.
The separation of complex IT and servicing arrangements can significantly impact the costs, timetable and documents required to effect a sale. Equally, completing that process can be essential to the transaction’s success, particularly given the increasing focus on safeguarding operational continuity of banking businesses to ensure that customers have uninterrupted access to banking arrangements.
In light of some recent high profile conduct investigations, such as alleged financial product mis-selling, conduct and compliance are key areas of focus and should be viewed against the broader backdrop of increased regulatory scrutiny of banking activities since the financial crisis. Key elements to be agreed include risk allocation for historic conduct issues, an approach to manage complaints and remediation in relation to past conduct, and engagement with regulators, including on customer messaging and (at least for retail/SME transactions) a communications plan to manage customer queries.
In the UK, IT and servicing arrangements played an important part in both Lloyds Banking Group’s 2014 failed divestment and then IPO of TSB which included over 630 branches and the 2012 failed banking business sale of over 300 branches by The Royal Bank of Scotland to Santander. In the latter case, the IT separation difficulties ultimately prevented the transaction from proceeding.
Alongside the operational complexity of separation, the selling bank and buyer should consider the potential reputational and regulatory impacts if they fail to meet required customer service standards and obligations in respect of branding and managing customer data.
19 Restoring confidence. The changing European banking landscape
Transitional servicing arrangements
Separation
Contractual protection for security over transferred assets
Agency access arrangements
Reverse transitional servicing arrangements
Box 15: Key separation issues
Employee secondment arrangements
Retained bankincluding data, brand etc.
Divested businessincluding data, brand etc.
Retained intragroup services, third party contracts and
IT systems
Customer securityover assets
Payment systems
Transferred intragroup services, third party contracts and
IT systems
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