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Bond Buyers Threat to Santander

A number of large institutional investors have threatened to stop buying bonds issued by Santander after Spain’s biggest bank offered to exchange some of its existing debt into new instruments at what they consider punitive terms.

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The investors say they are unhappy with the terms of Santander’s debt exchange, in which it plans to boost its capital by getting investors to exchange €6.8 billion ($9.05 billion) of “subordinated” bonds—debt that ranks below other creditors—into new senior notes. In response, some intend to boycott future offerings from the Spanish bank.

“It’s pretty unlikely Santander will be able to issue senior unsecured or covered bonds,” Roger Doig, senior financial analyst at Schroders, told attendees at a bank capital conference in London on Thursday.

George Grodzki, global head of credit research at Legal & General, also criticised the terms of the debt exchange at the conference.

Only 23.8 percent of the bondholders have agreed to the debt exchange, according to a statement from Santander on Thursday, underlining the move’s unpopularity among investors.

So-called ‘liability management exercises’ can help banks raise capital by shuffling their liabilities, but risk the ire of investors who may feel they are being short-changed.

Santander’s exchange offer affected a third of its total outstanding “lower tier 2 capital” junior debt with call dates—on which the bank can opt to pay back the debt—ranging from March 2012 to September 2014.

In return for the exchange, subordinated bondholders will receive debt maturing in December 2015 at a spread of 150 basis points above a benchmark rate. Santander said the offer will “effectively manage the group’s outstanding liabilities, taking into consideration prevailing market conditions”.

However, the deal incensed many investors. Santander’s subordinated debt currently trades at a much higher yield in the secondary market, and convention holds that banks redeem subordinated debt at call dates, despite there being no contractual obligation to do so.

Investors that refuse to accept Santander’s offer could be left with less liquid bond notes that they had previously expected would redeem at par in the coming three years.

Santander executives privately dismiss the threat of a “boycott” of a particular bank, since investors have been reluctant to buy bonds of any eurozone financial institution except at high yields since the middle of the year.

“They don’t like the price,” said one. “We used to redeem early because we could easily refinance them. Now we are going to redeem them when they make economic sense ... It’s one of the little side-shows of the crisis.”

European banks have announced a flurry of liability management dealsin recent weeks, after being asked by regulators to raise €106 billion worth of fresh capital. The exchanges have to balance the interests of a wide variety of investors, and the banks’ desire to boost core capital.

Deals have so far come from BNP Paribas and BPCE in France, and Espirito Santo in Portugal, though Santander’s €6.5 billion exchange has so far proven the most controversial.

“Funding stresses now embedded, leaving increased bank liability management exercises,” Société Générale analysts said in a note last week. “Santander’s was quite punitive, BNP’s offer fared better, but subordinated bond holders need to get used to LM exercises.”