ferdo
Utente Senior
Hedge fund Caius Capital, which has a short position on UniCredit bonds, is claiming that part of the proceeds the bank received from issuing €2.98 billion of CASHES in 2008 are not eligible as CET1 instruments. The fund has asked the European authorities to investigate the matter and believes the notes should be converted into ordinary shares of the Italian bank.
The conversion would impose losses on CASHES holders and Caius would profit from the transaction since it has a short position on the bonds. A conversion would mean bond investors take a loss of about 94% given they would receive about €5,000 to €6,000 worth of share for each €100,000 in bonds, based on the bond prospectus conversion price. The shares deliverable in this automatic conversion are worth approximately 6% of the face value of the CASHES.
UniCredit responded to the letter today ending its statement by saying that “ there are contractual features to deal with any regulatory development and preserve UniCredit capital position also through the automatic conversion of the Cashes instruments into ordinary shares.”
After Caius’ letter became public and after the UniCredit statement, the CASHES fell as much as 7 points to 66/67. UniCredit shares are quoted at €17.3, about 3% down on the day, mainly in reaction to political turbulence in Italy related to the difficulties in forming a new government after the March 4 general election.
UniCredit is due to report its results this Thursday, May 10, and as of the end of last year had a CET1 ratio of 13.73%, after it raised €13 billion in equity in February 2017.
Some investors told Reorg that the market expected a stronger statement from UniCredit in defense of the bonds’ position and that the current statement leaves the door open to a favorable interpretation of Caius argument and to a conversion in equity of the bonds.
The conversion would increase UniCredit stated CET1 by €609 million (the portion they currently include as fully eligible Tier 2), and save them about €125 million per year in payments to bondholders (at current Euribor rates).
In March 2017, some of the biggest holders of the CASHES included Carmignac, Algebris and Anima SGR, Reorg reported.
The bank acknowledged the letter and confirmed the treatment of CASHES was reviewed by the regulator and added that “the Cashes shares' current contribution to the overall capital position of the Bank has no material impact on the Group's regulatory ratios”.
The letter
The letter is directed to Andrea Enria Chairperson, European Banking Authority, with UniCredit CEO Jean Pierre Mustier and Danièle Nouy, chair of the Supervisory Board, ECB SSM, both cc-ed.
The fund says that it has “uncovered a further transaction that we believe is not being treated in compliance with the Capital Requirements Regulation or CRR” following an investigation it conducted into CET1 instruments in the EU.
In its letter Caius explains that it believes “UniCredit currently discloses €609 million of the proceeds received under the CASHES as eligible as Tier 2 capital under the fully loaded application of the CRR, and the remaining €2.374 billion as CET1. The fund believes the proceeds derived from the CASHES are ineligible as CET1 instruments and their existence also makes the ordinary shares of UniCredit ineligible as CET1 instruments. The Bank of Italy, the previous regulator, failed to correctly apply Union Law, and this failure has been perpetuated by the ECB SSM.
Caius Capital has identified ten breaches of the regulation, with a single breach sufficient to make the transaction ineligible as CET1. The most straightforward of these are:
1. CET1 instruments are required to be the most junior instruments issued and cannot rank equally with securities other than CET1 instruments. UniCredit is claiming CET1 treatment for ordinary shares which rank equally to instruments that it is claiming as Tier 2 (UniCredit states that €2,374 million of the proceeds from the CASHES are eligible as CET1 and €609 million are eligible as Tier 2 under the full implementation of the CRR);
2. Issuers should have full discretion as to whether distributions on a CET1 instrument are paid without nonpayment creating any restriction, e.g. obligation to cancel other payments or distributions, to ensure there is no disincentive for distributions to be canceled when the bank needs to conserve capital. However, if UniCredit were to cancel dividends on ordinary shares, it is restricted from paying distributions on the CASHES due to the Usufruct Agreement it has in place;
As a cancellation of dividends on ordinary shares restricts UniCredit from making other payments, and the ordinary shares rank equally with Tier 2 instruments, Caius believes all UniCredit ordinary shares (including those issued as part of the CASHES transaction) are ineligible as CET1. This would leave UniCredit with no CET1 instruments, and therefore grossly undercapitalized (Caius Capital estimates
In the letter, the fund formally requests under EBA Rules of Procedure for Investigation of Breach of Union Law Article 2(2) that the EBA use their powers under Regulation (EU) No 1093/2010 Article 17 to open an investigation for a Breach of Union Law in regards to the incorrect regulatory capital treatment derived by UniCredit from the CASHES (Convertible And Subordinated Hybrid Equity-Linked Securities) transaction.
The CASHES pre-date the CRR, and therefore were the responsibility of the Bank of Italy, as the national competent authority, to ascertain their correct treatment on implementation of the new regulation, the fund explains.
“The Bank of Italy and ECB SSM’s permission for UniCredit to treat the CASHES as currently disclosed undermines the European level playing field, and risks weakening the perceived quality of CET1 across the EU”, the letter says.
The CASHES transaction contains provisions that Caius believes, subject to certain conditions, allows the automatic conversion of the securities into UniCredit ordinary shares should there be more than an “insubstantial risk” that UniCredit would be subject to a regulatory or capital burden or cost under the transaction.
“Thus a more than insubstantial risk that the capital treatment will change (rather than a change being effected), is sufficient to trigger the conversion. Indeed we believe the threshold for an “Increased Burden Event” has already been achieved, and we would urge the execution of their automatic exchange procedure to preserve the robust solvency of the institution. We have copied the ECB on this letter in their role as lead supervisor due to the prudential implications that disqualification of all UniCredit’s CET1 instruments would have. Given we view this matter as highly relevant to investors in UniCredit, and European banks more broadly, we also intend to make the contents of this letter public,” Caius said.
In the letter Caius refers to its analysis of West Bromwich Building Society notes, which last year converted the fund’s claims for other instruments in response to concerns raised by Caius with regulators about their eligibility as CET1 capital.
Background
The bank’s CASHES are due on Dec. 15, 2050, and early termination is not possible. The coupon is crucial for the attractiveness of the payment flow. The bonds have usually traded at a 100 to 200 basis points premium to the more liquid additional Tier 1.
CASHES bonds were issued in January 2009 by trustee BNY Mellon (replaced by Mitsubishi in 2017) following Unicredit’s “failed” capital increase of €4 billion. The offering was for 972 million shares with a par value of €0.50 and regular dividend (from Jan. 1, 2008), according to the prospectus. In total, its value amounted to €2.9 billion.
According to the notes’ prospectus, CASHES are exchangeable for UniCredit shares. The conversion price is the recorded reference price of ordinary UniCredit shares at the close of the Italian stock exchange on Oct. 3, which was €3.083. Conversion is automatic upon the occurrence of certain events, including the following:
CASHES pay a quarterly coupon with an interest rate equal to three-month Euribor+450 bps on the nominal value of the bonds plus any amount exceeding a dividend yield of 8%, to be calculated on the basis of the price of the shares recorded during the 30 business days preceding approval of the financial statements.
The coupon is paid if cash dividends are distributed in relation to UniCredit shares and if profits are shown in the consolidated financial statements for the preceding financial year. Any amount due on any coupon that is not paid, either in full or in part and for any given period, is no longer due in any subsequent period.
The CASHES offering aimed at increasing UniCredit's capital but only marginally affected its consolidated liquidity because of its size. The funds received from the transaction were contributed to the bank’s core tier I capital, according to the prospectus.
The conversion would impose losses on CASHES holders and Caius would profit from the transaction since it has a short position on the bonds. A conversion would mean bond investors take a loss of about 94% given they would receive about €5,000 to €6,000 worth of share for each €100,000 in bonds, based on the bond prospectus conversion price. The shares deliverable in this automatic conversion are worth approximately 6% of the face value of the CASHES.
UniCredit responded to the letter today ending its statement by saying that “ there are contractual features to deal with any regulatory development and preserve UniCredit capital position also through the automatic conversion of the Cashes instruments into ordinary shares.”
After Caius’ letter became public and after the UniCredit statement, the CASHES fell as much as 7 points to 66/67. UniCredit shares are quoted at €17.3, about 3% down on the day, mainly in reaction to political turbulence in Italy related to the difficulties in forming a new government after the March 4 general election.
UniCredit is due to report its results this Thursday, May 10, and as of the end of last year had a CET1 ratio of 13.73%, after it raised €13 billion in equity in February 2017.
Some investors told Reorg that the market expected a stronger statement from UniCredit in defense of the bonds’ position and that the current statement leaves the door open to a favorable interpretation of Caius argument and to a conversion in equity of the bonds.
The conversion would increase UniCredit stated CET1 by €609 million (the portion they currently include as fully eligible Tier 2), and save them about €125 million per year in payments to bondholders (at current Euribor rates).
In March 2017, some of the biggest holders of the CASHES included Carmignac, Algebris and Anima SGR, Reorg reported.
The bank acknowledged the letter and confirmed the treatment of CASHES was reviewed by the regulator and added that “the Cashes shares' current contribution to the overall capital position of the Bank has no material impact on the Group's regulatory ratios”.
The letter
The letter is directed to Andrea Enria Chairperson, European Banking Authority, with UniCredit CEO Jean Pierre Mustier and Danièle Nouy, chair of the Supervisory Board, ECB SSM, both cc-ed.
The fund says that it has “uncovered a further transaction that we believe is not being treated in compliance with the Capital Requirements Regulation or CRR” following an investigation it conducted into CET1 instruments in the EU.
In its letter Caius explains that it believes “UniCredit currently discloses €609 million of the proceeds received under the CASHES as eligible as Tier 2 capital under the fully loaded application of the CRR, and the remaining €2.374 billion as CET1. The fund believes the proceeds derived from the CASHES are ineligible as CET1 instruments and their existence also makes the ordinary shares of UniCredit ineligible as CET1 instruments. The Bank of Italy, the previous regulator, failed to correctly apply Union Law, and this failure has been perpetuated by the ECB SSM.
Caius Capital has identified ten breaches of the regulation, with a single breach sufficient to make the transaction ineligible as CET1. The most straightforward of these are:
1. CET1 instruments are required to be the most junior instruments issued and cannot rank equally with securities other than CET1 instruments. UniCredit is claiming CET1 treatment for ordinary shares which rank equally to instruments that it is claiming as Tier 2 (UniCredit states that €2,374 million of the proceeds from the CASHES are eligible as CET1 and €609 million are eligible as Tier 2 under the full implementation of the CRR);
2. Issuers should have full discretion as to whether distributions on a CET1 instrument are paid without nonpayment creating any restriction, e.g. obligation to cancel other payments or distributions, to ensure there is no disincentive for distributions to be canceled when the bank needs to conserve capital. However, if UniCredit were to cancel dividends on ordinary shares, it is restricted from paying distributions on the CASHES due to the Usufruct Agreement it has in place;
As a cancellation of dividends on ordinary shares restricts UniCredit from making other payments, and the ordinary shares rank equally with Tier 2 instruments, Caius believes all UniCredit ordinary shares (including those issued as part of the CASHES transaction) are ineligible as CET1. This would leave UniCredit with no CET1 instruments, and therefore grossly undercapitalized (Caius Capital estimates
In the letter, the fund formally requests under EBA Rules of Procedure for Investigation of Breach of Union Law Article 2(2) that the EBA use their powers under Regulation (EU) No 1093/2010 Article 17 to open an investigation for a Breach of Union Law in regards to the incorrect regulatory capital treatment derived by UniCredit from the CASHES (Convertible And Subordinated Hybrid Equity-Linked Securities) transaction.
The CASHES pre-date the CRR, and therefore were the responsibility of the Bank of Italy, as the national competent authority, to ascertain their correct treatment on implementation of the new regulation, the fund explains.
“The Bank of Italy and ECB SSM’s permission for UniCredit to treat the CASHES as currently disclosed undermines the European level playing field, and risks weakening the perceived quality of CET1 across the EU”, the letter says.
The CASHES transaction contains provisions that Caius believes, subject to certain conditions, allows the automatic conversion of the securities into UniCredit ordinary shares should there be more than an “insubstantial risk” that UniCredit would be subject to a regulatory or capital burden or cost under the transaction.
“Thus a more than insubstantial risk that the capital treatment will change (rather than a change being effected), is sufficient to trigger the conversion. Indeed we believe the threshold for an “Increased Burden Event” has already been achieved, and we would urge the execution of their automatic exchange procedure to preserve the robust solvency of the institution. We have copied the ECB on this letter in their role as lead supervisor due to the prudential implications that disqualification of all UniCredit’s CET1 instruments would have. Given we view this matter as highly relevant to investors in UniCredit, and European banks more broadly, we also intend to make the contents of this letter public,” Caius said.
In the letter Caius refers to its analysis of West Bromwich Building Society notes, which last year converted the fund’s claims for other instruments in response to concerns raised by Caius with regulators about their eligibility as CET1 capital.
Background
The bank’s CASHES are due on Dec. 15, 2050, and early termination is not possible. The coupon is crucial for the attractiveness of the payment flow. The bonds have usually traded at a 100 to 200 basis points premium to the more liquid additional Tier 1.
CASHES bonds were issued in January 2009 by trustee BNY Mellon (replaced by Mitsubishi in 2017) following Unicredit’s “failed” capital increase of €4 billion. The offering was for 972 million shares with a par value of €0.50 and regular dividend (from Jan. 1, 2008), according to the prospectus. In total, its value amounted to €2.9 billion.
According to the notes’ prospectus, CASHES are exchangeable for UniCredit shares. The conversion price is the recorded reference price of ordinary UniCredit shares at the close of the Italian stock exchange on Oct. 3, which was €3.083. Conversion is automatic upon the occurrence of certain events, including the following:
- From the seventh year after issue, the market price on the Italian stock exchange of UniCredit’s ordinary shares exceeds 150% of the reference price (that is, €4.625, subject to any adjustments) for at least 20 days during any given period of 30 consecutive days;
- UniCredit’s aggregate, consolidated or standalone capital requirement falls below 5% (or any other threshold set out in the applicable supervisory legislation for the purpose of absorbing losses through innovative capital instruments);
- UniCredit breaches any of its payment obligations undertaken pursuant to the usufruct contract;
- UniCredit is/has been declared insolvent or is/has been in liquidation;
- The depository bank is/has been declared insolvent or is/has been in liquidation.
CASHES pay a quarterly coupon with an interest rate equal to three-month Euribor+450 bps on the nominal value of the bonds plus any amount exceeding a dividend yield of 8%, to be calculated on the basis of the price of the shares recorded during the 30 business days preceding approval of the financial statements.
The coupon is paid if cash dividends are distributed in relation to UniCredit shares and if profits are shown in the consolidated financial statements for the preceding financial year. Any amount due on any coupon that is not paid, either in full or in part and for any given period, is no longer due in any subsequent period.
The CASHES offering aimed at increasing UniCredit's capital but only marginally affected its consolidated liquidity because of its size. The funds received from the transaction were contributed to the bank’s core tier I capital, according to the prospectus.
