March 23, 2017 / 9:54 AM / in 8 months

UPDATE 2-Caixa Geral de Depositos AT1 convinces investors, but at a cost

* CGD pays high price for Portugal’s first AT1

* Debt sale central to state-owned lender’s recap plan (Adds quotes, detail)

By Alice Gledhill

LONDON, March 23 (IFR) - Caixa Geral de Depositos has cajoled investors into buying €500m of its most deeply subordinated debt, a key element in the state-owned bank’s recap plan, but the 10.75% coupon is the highest since the market’s infancy in 2013.

Orders for the perpetual non-call five-year bond, also Portugal’s first Additional Tier 1 sale, have passed €2bn to more than cover the no-grow €500m target.

That demand enabled leads to tighten initial price thoughts of 11%-11.5%, but it is still the highest coupon for a benchmark euro AT1 since a €500m 11.5% deal from Banco Popular Espanol issued in October 2013.

Pricing power lay firmly in the hands of investors, who know perfectly well that the issuer has no choice but to get the trade done.

“They have a gun to their head, that’s why it’s so wide,” said a banker off the deal early on Thursday.

CreditSights analysts saw fair value considerably higher, at 12%. The issuer however was hoping to land around or even inside 10%, according to sources. The bank could not be immediately reached for comment.

The debt is part of a recapitalisation package agreed with European authorities to nurse the lender back to health, which also includes a €2.5bn capital injection from the state and a further €430m of AT1 issuance.

The bank reported phased-in Common Equity Tier 1 and total ratios of just 7% and 8.1% respectively as of December 2016, among the worst in Europe. It is not expected to return to profitability until 2018.

SWIMMING AGAINST THE TIDE

CGD’s investment case is not helped by the broader economic picture in Portugal, a jurisdiction described as “uninvestible” by one investor.

Fitch, expected to rate the bond at B-, has a negative outlook on the country’s banking sector, reflecting intensified pressure on capital from weak profitability and asset quality amid a highly indebted economy with low growth prospects.

The shock transfer of senior bonds in late 2015 from state-rescued Novo Banco to Banco Espirito Santo, which left bondholders nursing severe losses, also continues to cast a shadow over the sector and provided investors with further ammunition.

Added to that, market access for Portuguese banks had been completely untested since 2015, even in a covered format - considered the safest type of bank debt.

“They are tied to make this deal a success and investors have taken this into account,” said a second investor.

“They are also unfortunately paying up for the erratic approach to resolution by the Portuguese authorities in 2014 and December 2015.”

TAKING A GAMBLE

Rating agency DBRS this week voiced concerns around the challenges facing CGD’s strategic plan for 2017 to 2020, particularly the targeted reduction of NPLs and return to sustainable profitability in 2018.

It warned that a high additional funding cost for AT1 capital “could add to CGD’s burden in returning to sustainable profits, particularly considering the bank’s weak earnings generation and net losses for the sixth consecutive year.”

Yet despite those reservations, parts of the buyside clearly buy into the turnaround story. The issuer met around 120 investors during a recent roadshow.

“It’s a very binary investment,” said a second banker from the deal.

“You’re either going to be a hero or an absolute buffoon. If you get it right, it’ll rally really significantly, but if anything goes wrong with Portugal it will be wiped out.”

The bonds will be written down on a temporary basis should the bank’s Common Equity Tier 1 ratio fall below 5.125%.

The deal is expected to price later today via joint leads managers Barclays, Caixa - Banco de Investimento, Citigroup, Deutsche Bank and JP Morgan. (Reporting by Alice Gledhill, Editing by Helene Durand, Julian Baker)

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