A bond partially by ballot

Financial Article 409 by Edward Rizzo - Nov 12, 2015

The official details of the long-awaited debt issue by Bank of Valletta plc were published earlier this week.

BOV issued a Base Prospectus dated 16 October 2015 and a Supplement dated 9 November 2015 in connection with the recently announced €150 million Subordinated Debt Issuance Programme. BOV also published  the Final Terms dated 10 November 2015 related to the issuance of a total of €75 million representing the First and Second Series under the First Tranche of the Programme.

The first tranche of €75 million in subordinated notes are for a 15-year period (maturing in 2030) at a coupon of 3.5% per annum, payable semi-annually in February and August.

BOV may issue further tranches of these notes or other notes with completely different terms and conditions up to a total aggregate amount of an additional €75 million within the next 12 months.

The BOV debt issuance programme has some different characteristics to the other bond issues and Malta Government Stock offerings that local investors have been accustomed to recently.

As a start, it is worth explaining that under a debt issuance programme, a fixed interest rate security is normally defined as a note rather than a bond. However, these notes have identical attributes to the typical bond issues that have been launched on the local market to date with a fixed rate of interest and a final maturity date.

“… some investors who apply for Series 1 and who will not be drawn up by ballot, will not receive any allotment …”

In line with regulatory requirements, these BOV notes have been classified as a complex financial instrument since the debt is subordinated. Investors must understand the meaning of subordination especially following the enactment of the European Bank Recovery and Resolution Directive (BRRD), effective as from 2 July 2014. A very topical and interesting article was published in The Times of Malta by Dr Conrad Portanier on 26 October providing an overview of the new directive and the implications for various types of investors (equity, subordinated/unsecured bondholders or senior/unsubordinated bondholders) as well as depositors. This directive was in part issued to ensure that in the future, governments will not use taxpayers money to ‘bailout’ any financial institution as happened in various jurisdictions during the international financial crisis. The concept is now on ‘bail-ins’ whereby the risk is placed on shareholders, bondholders and depositors rather than taxpayers (as was the case in the latest banking crisis in Greece and Cyprus).

In essence, subordination means that the rights and claims of any holders of such bonds or notes in respect of the payment of capital and interest will, in the event of financial difficulties being faced by the issuer in question (in this case BOV), rank after the claims of all senior indebtedness and will not be repaid until all other senior indebtedness outstanding at the time has been settled. As such, should BOV find itself in a difficult financial position, losses are first absorbed by Tier 1 capital (equivalent to shareholders of the Bank) and subsequently by Tier 2 capital. In view of the fact that the Notes being issued by BOV qualify as Tier 2 capital, the principal amount of the Notes, including accrued but unpaid interest in respect thereof, may be fully or partially written down or converted into Tier 1 capital in accordance with the above ranking. BOV has other subordinated bonds in issue that also fall within this category. These are the €50 million 5.35% bonds due 15 June 2019 and the €70 million 4.8% bonds due 15 March 2020. As such, these subordinated bonds as well as the notes being issued now rank below the Bank’s depositors.

The first tranche of this subordinated debt issuance programme is split into two different series. Series 1 applies to those investors subscribing for a minimum of €25,000 while under Series 2, investors may apply for a minimum of €5,000. The lists of such intermediaries who can process applications are available in both of the Final Terms.

A total of €40 million is being reserved for preferred applicants, i.e. shareholders of BOV as at 19 October 2015 (totaling over 19,000) as well as employees and Directors. The balance of €35 million is open to all other investors.

If the aggregate nominal amount applied for by both preferred applicants and the general public is in excess of €75 million, BOV will determine the total amount issued under Series 1 and Series 2 possibly reflecting the total amount of applications received under each series. Subsequently, it will scale down each application under Series 1 to the minimum subscription amount of €25,000 and also scale down each application under Series 2 to an amount to be determined upon closure depending on the absolute number of applications received.

In the case that after this scaling down, the aggregate value remains above the total amount to be allocated under Series 1, a ballot will be held in respect of applications under Series 1. Only the drawn applications under Series 1 will be allocated the minimum amount of €25,000. As such, some investors who apply for Series 1 (minimum €25,000) and who will not be drawn up by ballot, will not receive any allotment.

Given the sizeable liquidity across the local financial system which was again evident in the last bond issue of Hili Properties plc, this is a very likely possibility. Hili Properties raised over €220 million from almost 9,000 applicants.

Assuming the €75 million in the BOV issue is split equally between Series 1 and Series 2, i.e. €37.5 million each, only 1,500 applicants will receive an allotment in Series 1 while the others not drawn up by ballot will be excluded. Meanwhile, Series 2 applicants will all receive some form of allotment which may be scaled down depending on the number of applications received.

Due to the staggering rise in the investor population resulting from the very low interest rates on savings accounts and fixed deposits across most local banks, the procedure being adopted in respect of this bond issue is going to leave many investors extremely disappointed once again. Although all applicants will surely not receive the full amount applied for, some investors applying in the Series 1 notes who will not be drawn up by ballot will end up without any allotment.

With the demand from thousands of applicants for the large majority of bond issues by far exceeding the total amount on offer, and the resultant allotments now becoming ridiculously low for most applicants, future public offers are likely to be carried out differently than they have done to date.

Such a development would be no different to what happened overseas some years back. In fact, public offerings by direct application to the issuer no longer take place. Instead, issuing companies place their securities via financial intermediaries who in turn offer these to their own clients. Although some disappointed applicants in recent issues have taken appropriate action to buy more bonds on the market to achieve a more meaningful amount within their investment portfolios, others need to start becoming more accustomed to also acquire bonds at a premium to par value if they wish to invest their idle funds within a reasonable timeframe. This development is likely to gather momentum in the near future.

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