July 25, 2012 / 10:03 AM / 5 years ago

US financials break records in hot prefs market

* Financial institutions take advantage of strong market

* Record-low coupons set on replacements for TruPS

* US$80bn of new perp prefs slated in coming years

By Danielle Robinson

NEW YORK, July 25 (IFR) - GECC and US regional bank BB&T set record-low coupons on US$2.75bn of Tier 1 capital on Tuesday, by appealing to both retail and institutional investors willing to buy riskier securities at higher yields.

GECC priced US$1.75bn of perpetual non-call 10-year preferreds at a yield of 6.25%, the lowest yield on a capital security that has been targeted almost entirely to institutional investors.

BB&T meanwhile placed US$1bn of perpetual non-call five year preferreds at just 5.625%, the lowest yield of any Tier 1 capital issue yet sold in the retail-targeted US$25 par preferred market.

About 75% of its deal was placed with retail investors and 25% to institutional, reflecting the jump in retail demand in the past month as US$26bn of bank trust preferred securities are redeemed by banks.

Both financials ignored a bad day for equities and lacklustre performance on their own stock prices, eager instead to take advantage of the fact that preferreds are now among the hottest asset classes in the US.

"We are seeing financial issuers taking advantage of extraordinary technicals," said Justin D'Ercole, head of Americas investment grade syndicate at Barclays.

"Not only are rates at historic lows, but we have seen more than US$26bn of trust preferred securities redeemed in the last month that investors are keen to re-invest in the preferred market."

BB&T is one of a number of the biggest US financial institutions to announce the redemption of TruPS after the Federal Reserve issued a notice of proposed rulemaking in June that confirmed that US banks will need to phase out TruPS as Tier 1 securities beginning January 2013.

Some strategists are expecting as much as US$80bn of new perpetual preferreds to be issued over the next few years, as banks replace TruPS and, like GECC, look to improve the cost of their Tier 1 capital by having the maximum amount of non-common Tier 1 perpetual preferreds in their capital structure.

Bankers expect other banks to issue in the preferred market in coming weeks, as soon as the earnings season is over.

"We expect it (the preferred new issue market) to be busy right through to the middle of August," said Kevin Ryan, co-head of financial institutions capital markets at Morgan Stanley.

The feeding frenzy in the market has sent yields on outstanding prefs screaming in over the past few weeks, enabling banks to replace TruPS with new securities at record low coupons.

GECC's 6.25% coupon, for instance, compared with the 7.125% coupon on its identically-structured US$2.25bn non-cumulative perpetual non-call 10-year done on June 7. That was trading around 6.05% before the new offering was announced.

Although GECC paid a 20bp new issue concession on the coupon, it was able to shave off almost 60bp on the cost of the security if, however unlikely, it isn't called in 10 years and instead turns into a floating rate note.

The cost, if it does switch to floating, is three-month Libor plus 470.4bp, compared to the 529.6bp level on the 7.125% deal done in June.

GECC priced the new deal with a senior-to-preferred spread differential of around 310bp, about the same as the 315-320bp margin for the 7.125% offering done in June.

DESPERATE HUNT FOR YIELD

Demand for BB&T's 5.625% deal was so strong that it paid nothing in the way of new issue concession. Its previous preferred, a US$500m 5.85% perp non-call five-year in April, was trading around the same level as the coupon on the new US$1bn offering.

Preferreds are one of the riskiest pieces of bank 'debt' an investor can buy, as they are designed to absorb losses at the same rate as common stock if the bank fails.

Despite the extra risk, bond investors are willing to buy them, especially if they are issued by good credits like GECC and BB&T.

"A lot of the demand for preferreds is being driven by a basic need for yield," said Andrew Karp, head of US investment grade debt syndicate at Bank of America Merrill Lynch. "There are only a few ways an investor can get incremental yield and one of the more popular methods is continuing down the capital structure in very high quality names."

GECC prefers to issue entirely to institutional investors because of the disclosure requirements for a retail deal. The fees are also less, at around 1-2%, compared with around 3.1% for retail deals.

Although it looks as if it paid a lot more for its deal than BB&T, it was considered to be very competitive pricing, considering that it's harder to get almost US$2bn done in the retail preferred market.

It's also likely that GECC would have received a tighter pricing than 6.25% if it had a call at five- rather than 10-years.

Another factor to take into account is that GECC's senior unsecured bonds trade about 50bp behind BB&T in the five year part of the yield curve. (Reporting by Danielle Robinson; Editing by Alex Chambers and Julian Baker)

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