Riskiest Bank Bonds’ Next Test is an $84 Billion Redemption Wave

After bouncing back from Credit Suisse’s AT1 writedown debacle, the market for European banks’ riskiest debt is set to be tested again, with $84 billion notes facing calls in the next two years.

(Bloomberg) — After bouncing back from Credit Suisse’s AT1 writedown debacle, the market for European banks’ riskiest debt is set to be tested again, with $84 billion notes facing calls in the next two years.

The wave of first call dates may cause a flood of AT1 issuance, because banks typically replace this type of debt with new notes at the earliest opportunity. Some, like Austria’s Erste Group Bank AG and Italy’s Intesa Sanpaolo SpA, have already started to get ahead of the curve with new deals. UBS Group AG said it is monitoring the market as a jumbo $2.5 billion AT1 note approaches its first call.

“It now makes sense for banks to pre-finance for next year as momentum is good,” said Andrea Seminara, chief executive officer at Redhedge Asset Management. “There has been strong feedback and good appetite,” he said.

Recent euro-denominated AT1s — including Erste and Intesa’s deals — drew almost three times as many orders as the issuance amounts, based on data compiled by Bloomberg. It’s a swift recovery for a market that was dealt a huge blow by the controversial wipeout of $17 billion of Credit Suisse’s AT1s as part of the state-brokered takeover by UBS Group AG in March.

The move — which also saw equity holders retain some value — initially sparked a rout amid concerns about the pecking order of claims when a lender is in trouble. Investors were also worried that soaring refinancing costs would prompt banks to leave their bonds outstanding beyond the first call, breaking market convention. But lenders such as HSBC Holdings Plc and Barclays Plc continued to repurchase their AT1s, bringing calm to the market over the past few months.

“Last week’s events were pretty constructive in showing the investiblility of AT1s — Intesa showing the market is open for replacement while UBS had a great set of results,” said Gordon Shannon, a portfolio manager for TwentyFour Asset Management LLP. 

TwentyFour bought AT1s issued by the likes of Barclays, Lloyds Banking Group Plc, ING Groep NV and BNP Paribas SA this summer, adding to its existing holdings of AT1s issued by the UK’s Nationwide Building Society.

AT1 bonds — also known as contingent convertibles — help banks comply with capital requirements and were created after the financial crisis as a way to impose losses on creditors without using taxpayer money. The notes pay a fixed rate until their first call, and then switch to a floating rate comprising a market benchmark and a spread. If banks can get a similar or better spread in the market, they typically replace the note.

Still, it’s not guaranteed that lenders will call. Last month, Banco Santander SA opted not to redeem a €1 billion bond because of refinancing costs that would have made issuing a new bond uneconomic.

The recovery of the AT1 market post-Credit Suisse will now come up against the sheer volume of potential issuance by Europe’s banks next year, and it remains to be seen if demand will be as hot as it has been for recent deals.

Banks are already adapting: Both Erste and Intesa combined a new AT1 issue with an early buyback of an older note with a first call date next year. It’s a more proactive approach than in the past, when lenders would typically wait to exercise call options.

Pre-financing using a combination of buybacks and new issues is becoming a mainstream feature. This way of dealing with the debt offers investors a way out of the old AT1 bond, usually at good levels, and helps to make room for the new issue, according to ING senior financials strategist Suvi Platerink Kosonen.

“It has now got obvious that the AT1 market is wide open for new issuers,” she said. “It looks like in particular a new deal in combination with a tender offer works in this market.”

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