In December 2014, NJJ Capital announced it was going to acquire Orange Switzerland. Just a month later, the Swiss National Bank (SNB) shocked markets by removing the floor on the euro/Swiss franc rate. This sent the Swiss currency soaring – and caused Orange Switzerland's existing cross-currency swap hedges to become deeply out-of-the-money.
So when the company looked to do a €1.5 billion ($1.6 billion) and Sfr450 million ($440 million) refinancing in April after the acquisition closed in February – which would require managing out of old hedges and entering new ones – the company hardly seemed to be in a position of leverage.
Enter Goldman Sachs, which stepped in to provide a solution that not only made a messy transaction very smooth, but also saved them millions in the process. It achieved this by convincing existing counterparty banks to not fully unwind existing swaps, but to take on new at-market swaps restructured by Goldman from the old swaps, while keeping the credit lines from those previous swaps in place.
"The easy way would have been for those banks in front of us with the hedge to just say ‘pay us back' and that's it. But what was difficult, and what Goldman Sachs did, was create a dialogue and some sort of leverage at some point that allowed them to say to the other counterparties, ‘you are better renegotiating these hedges with the issuer'," says Olivier Rosenfeld, a member of the NJJ team.
"To me, there was a big chance of failure, or nothing happening, and they managed to pull out a lot of value for us. We are talking about savings in the double digits of millions of euros," he added.
Goldman Sachs took on Orange Switzerland's 12 euro/Swiss franc cross-currency swaps, totalling a notional €1.2 billion with remaining maturities of less than two years, which were spread across five banks. The US bank then restructured them into new five-year, at-market swaps to match the new financing.
To me, there was a big chance of failure, or nothing happening, and they managed to pull out a lot of value for us. We are talking about savings in the double digits of millions of euros
Olivier Rosenfeld, NJJ
While the maturities were extended, the new swaps started with a cleaner mark-to-market, meaning the credit exposure was similar to the old trades. This meant the company only had to pay a small incremental charge for extending the swaps, instead of a larger cost if it unwound and had to set up new credit lines.
The size of the market risk was around five times the daily trading volume in the euro/Swiss franc swap market, which at that time had not yet recovered from the SNB's removal of the currency floor. Goldman kept this market risk and managed it on its balance sheet. Then, together with the client's adviser, it auctioned off the credit risk to six banks – five existing counterparties and one new counterparty.
"It was a commercial discussion about being in the new swap – so we said, ‘Look, if you want to have a role in the new swap, you need to be commercial about giving the benefit of freeing up the credit line. And there was enough competitive attention around that, and relationship aspects with the client," says Gudrun Wolff, a managing director at Goldman Sachs in London, who led the deal.
From the client's point of view, what would have been 12 separate exchanges to settle the mark-to-market on the existing swaps was boiled down to one payment to Goldman Sachs, followed by the delivery of the new swaps that was contingent on the settlement of the new bond financing.
As part of the deal, Goldman had to get the bank counterparties in the original swaps to agree to face it for the interdealer market risk hedge for the new trades. This entailed moving to a US dollar credit support annex (CSA), and using a currency-specific discounting rate to value future cashflows.
Orange Switzerland had been in talks with at least four other major investment banks regarding its situation, and only Goldman Sachs was able to provide any feasible solution.
"No-one would do it. This was a fairly unique situation, even for Goldman Sachs, in light of the unpegging of the Swiss franc. But Goldman took a bit of a leap of faith. No-one had done this before, no-one was ready to take on this kind of challenge except Goldman Sachs," says Rosenfeld.
Another client needed a large interest rate hedge with a credit auction similar to Orange Switzerland, but didn't want to telegraph the deal to the market immediately. Goldman Sachs executed the trade but waited five months to syndicate the credit risk – a significantly longer time than the average four or five days for similar deals.
Goldman is not afraid of putting in a whole lot of effort up front. Frankly, the likelihood of this deal going forward was very small; it had never been done before, and the risks they were dealing with were very different. They rolled up their sleeves and got it done
Goldman Sachs client
The larger time gap means a higher likelihood the mark-to-market will move from zero before the credit risk is actually novated. To combat this, Goldman allowed banks participating in the syndication to take on the credit risk at a pre-agreed zero mark-to-market, taking the variable off-market part onto its own balance sheet.
"The solution may seem straightforward in practice. But it requires a very constructive legal team, credit valuation adjustment team, the operations team for the booking – a lot of things have to fall into place to get this done. Risk appetite is key, and I think some of our competitors may balk at the risk or the complexity," says Steve Windsor, co-head of the Europe, Middle East and Africa investment-grade debt capital markets and risk solutions team at Goldman Sachs in London.
The client appreciated the bank's work: "Goldman is not afraid of putting in a whole lot of effort up front. Frankly, the likelihood of this deal going forward was very small – it had never been done before, and the risks they were dealing with were very different. They rolled up their sleeves and got it done," says a member of the company's infrastructure team.
"They are not followers. I wouldn't go to them to underwrite a plain vanilla swap. I go to them when there is something no-one else can help you with, and there they can create value more than any other bank. Yes they're expensive, but compared to what? Because there is no comparison. No-one else could propose this solution."
The Goldman solutions reflect the overall reason why the bank wins the award. Not only are its innovations smart, it is arguably the only bank with the capability to do them, from both an innovation and a balance sheet perspective.
"Clients require not only risk management advice but also the ability to execute upon the proposed solution. At times, you need to match brains with brawn. We offer creative solutions paired with what is still a large and leading securities division. We have the ability to not just offer advice, but to actually warehouse risk and distribute it through our global securities division," says Jim Esposito, head of Goldman Sachs' global financing group in London.
The brawn is evident in the sheer size of the transactions it can do: for example, Goldman Sachs took a £1.6 billion second lien mortgage loan portfolio from Barclays' non-core division onto its balance sheet in September. The deal requires the US bank to warehouse the risk for around a year until it refinances through securitisations.
Balance sheet risk management
Goldman also deploys its own skills at balance sheet risk management to help clients. When Spain's Banco Sabadell acquired UK retail bank TSB in June, it was a huge transaction that entailed significant currency risk, given it was a sterling-denominated acquisition by a bank with a euro profile. There was an added twist – Banco Sabadell had no control over when exactly each existing TSB shareholder would accept the offer to sell their shares.
Goldman Sachs helped the bank analyse how the sterling exposure would impact its capital structure, and assisted it in finding the most efficient long-term hedging strategy and short-term settlement mechanics. The timing of the hedges was contingent on the acceptance of the deal by TSB's shareholders.
"They provided valuable analysis that was used to design a hedging strategy for the currency risk embedded in the acquisition. What was particularly good was the flexibility they had in allowing the swap to be executed on different dates – though in exchange for that flexibility we had to agree on pricing, but we did finally come to a level we thought was fair," says Sergio Palavecino, chief financial officer of Banco Sabadell in Barcelona.
The deal demonstrated how Goldman ropes in people from across the bank for each solution, with its strong mergers and acquisitions team providing in-depth expertise on pricing probabilities.
"We don't have risk management sitting in a silo. We have risk management working with banking teams and a capital structure team, and we tend to look at it along with the capital impact, and the impact on equity valuation. All that allows us to size the hedge correctly, and the Sabadell deal is an example of where we applied that," says Abhishek Kapur, a managing director in the fixed income structuring team at Goldman Sachs in London.
The US bank also came up with unique credit risk solutions that allowed clients to carry out transactions that otherwise may have been impossible. It helped one corporate that was effectively shut out of the cross-currency swap market due to a low credit rating decrease its funding costs by 2% by converting its US dollar debt issuance into euros, to take advantage of the expected long-term appreciation of the euro implied by forward rates.
It did this by convincing it to collateralise a 30-year cross-currency swap. Talking a corporate around to signing a CSA is always tricky, given that it exposes the company to liquidity risk. Goldman, however, sweetened the deal by putting a cap on the amount of variation margin the corporate would have to post, at around 20% of the notional of the swap.
The swap was structured to include a coupon that was the same for both counterparties to reduce the forward mark-to-market the corporate would be expected to owe the bank on the latter's balance sheet – which allowed Goldman to reduce its counterparty credit risk charges. The swap was then split into a vanilla trade that qualified for hedge accounting with the bond, and an annuity to make up for the actual difference between the coupons.
"Goldman Sachs gave us the whole package, from identifying what was a very unique and interesting opportunity, to the structuring, and fitting the transaction to our accounting needs and the economics of our company," says a member of the company's group treasury.
The week in Risk.net, May 19-25 2017Receive this by email