Michelin: setting the standard

Carola Schenk examines the Swiss Re/SocGen deal for Michelin – the first bank and insurer syndication

The convergence of the banking and insurance sectors in the market for alternative financial risk management solutions is imposing increasing competitive pressures on both industries. However, a recent deal structured jointly by Swiss Re New Markets (SRNM) and Société Générale (SG) illustrates that there is scope for mutually beneficial co-operation. The transaction also breaks new ground in corporate risk financing, and reveals how corporate thinking on risk management is changing.

Earlier this year, Compagnie Financière Michelin (CFM), the Switzerland-based financial and holding arm of the Michelin tyre group, was seeking an option, but not an obligation, to draw on a capital reserve, says Jacques Tierny, deputy chief financial officer of Michelin, who is based in Fribourg, Switzerland, and Clermont-Ferrand, France. CFM’s main goal was to be able to take advantage of business opportunities such as acquisitions, partnerships and/or the need for restructuring, if and when they arise. SG and SRNM did the trick: they co-arranged for CFM a $1 billion 12-year committed subordinated loan facility – the first combined bank and insurance capital facility.

Replacement
The transaction replaces a 15-year subordinated loan of a similar credit volume, which CFM took up in 1990. This year’s deal evolved on the back of a long-term relationship with two individuals closely involved in the original loan – Tom Skwarek and Benoît de Font-Réaulx, at the time, syndication manager and relationship manager, respectively, at JP Morgan, the lead manager for the 1990 loan. Skwarek, now a director at SRNM, and de Font-Réaulx, now a senior banker at SG, are also CFM’s key advisers in the new deal.

Tierny says the original loan had served as bridge equity capital to reduce the risk on its balance sheet resulting from what has been Michelin’s largest acquisition – Uniroyal Goodrich Tyre Company of the US – executed in 1990. When it came to remarketing that loan earlier this year, the group decided it was too expensive, as it was only five years away from maturity. “You cannot do a strategic investment for only five years,” Tierny adds. He was eager to pay it back – as he did in June – and look for an alternative, which would better meet the company’s needs.

Risky
He recalls that Skwarek had spoken to him six to 12 months ago about contingent capital. At first, he says, he considered this to be too risky – fearing banks would interpret it negatively should Michelin draw on such a facility. However, following internal discussions, he changed his mind. “I needed time to get acquainted with the idea and then I thought it was excellent,” he notes. He also feels that following the group’s restructuring in 1999, Michelin is better prepared to face counter-cycles given its broad industry and geographic diversification.

“The business risk of Michelin is very low,” he says. Even with a 1:1 debt-to-equity ratio, there is little volatility, and value-at-risk is at 20–25%, which is close to the optimum, he notes. Michelin needs to use some debt to maximise the value for shareholders, he stresses. “It would be silly to sell equity when the old economy is not so well regarded by investors and our share price is only trading at 110% of book value,” he adds.
A SocGen team, headed by de Font-Réaulx, had also approached Tierny with a proposal, which, however, “did not exactly match our needs”. Therefore, Tierny asked Skwarek and de Font-Réaulx to structure a joint solution, which would give CFM the flexibility he was seeking.

Under the terms of the joint SG/SRNM transaction, CFM has guaranteed access to a bank credit facility for five years, ie, up to 2005, and the option to draw under certain conditions on an insurance facility for five years. The trigger event for the latter is a fall in the combined average annual GDP growth rate in Michelin’s main markets – the euro zone and the US – below a certain level. This level is set at 1.5% in the first three years, and 2% in the last two years of the five-year option. The insurance trigger arises from the fact that Michelin’s revenues are highly correlated to GDP growth in these markets. It was calculated on the basis of scenario tests executed with a stochastic model, which CFM bought jointly with SRNM for this particular purpose, details Tierny. The idea was that if GDP fell, this could provide an opportunity for restructuring, he explains. This transaction also gives Michelin’s shareholders the confidence that the group has the resources to weather any crisis, as well as to make an acquisition without equity increases, adds de Font-Réaulx.

If drawn, the subordinated loans can be outstanding to maturity in 2012. CFM pays an annual fee of 35 basis points and of 30bp for the bank credit and insurance facilities, respectively. Each facility, if drawn, will be repriced through a global auction in years six, eight and 10. The aim is to cut costs, says Tierny. CFM achieved significant cost reductions when it last remarketed the original subordinated loan five years ago, cutting prices from 120bp to 60bp, he observes. “Investors were interested in our credit risk,” he quips. Tierny hopes that, if necessary, it could achieve similar cost savings with the auctions.
“If it [the facility] is drawn, it flips into the previously tried auction technique,” adds Skwarek, noting the auctions relating to CFM’s original loan typically cleared at around 60bp. The cost of the SRNM/SG transaction is well below what public markets would offer and the auction mechanism can cut costs even further. The higher fee for the bank credit facility, Skwarek adds, derives from the absence of a trigger. CFM can draw on that facility for liquidity if needed, for example, for an acquisition. It is the first time that the reinsurance and insurance sector have provided committed capital to a corporate, he notes. To date, such transactions have taken place, but within the sector.

Objective
Looking ahead, Michelin’s Tierny says he does not expect to draw on the facility either this year or next, simply because he does not anticipate any business opportunities arising. On the take-up of the deal by the banking and insurance industries, he comments: “We began with an objective of $500 million”, which was significantly surpassed. Institutions – whether banks or insurers – that took part in the deal “have a very good ticket” for doing business with Michelin in the future, he says. “The commitment... is very important [for us],” he notes. The list of participants comprises BNP-Paribas, Crédit Lyonnais, Crédit Mutuel Banque Populaire and several foreign banks and insurers, including Winterthur.

The challenge in bringing together banks and insurers in this deal, Skwarek says, was to understand the motivation for each side and create a large enough market. Insurers typically focus on short-term earnings cover; banks, while willing to make long-term commitments, tend to avoid adverse risk. “We got them to speak the same language,” he rejoices. Matching a bank with an insurance credit facility gives the end-client a very firm basis, he notes.

SRNM has since structured several similar transactions for corporates, insurers and banks in member states of the Organisation for Economic Co-operation and Development, but none has been as large as the CFM deal. Skwarek would not reveal details beyond noting that corporates seek a minimum of $500 million with such structures.

As for CFM, Tierny says: “We don’t plan to use similar structures... the rest of our [risk] financing will be refinanced with normal senior structures.” It is now focusing on short-term senior financing instruments such as its treasury-bill programme in France. Nevertheless, Tierny does not exclude the possibility of Michelin issuing euro notes or medium-term notes. However, for it to do so, he adds, “we had better have a [credit] rating”. And, he says, he will not go to the five-to-10-year Eurobond markets unless these become cheaper. “Time is becoming very expensive,” he notes.

CFM has a system of internal risk-adjusted return on (economic) capital for ensuring the optimal debt and equity consumption for all of Michelin’s operations. “We have an integrated industrial and financial asset and liability management [approach]... just like the banks with their tier-one and tier-two capital,” he adds.

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