Rush of AT1 Supply
The period following the full year results releases from the banks is typically followed by large volumes of subordinated bond supply from the banks. This year is no exception as the pace of new issues is ramping up, in particular in the higher beta Additional Tier 1 (AT1) securities; colloquially known as Coco bonds. Already this week there have been new benchmark issues from BBVA, Barclays and BNP, taking 2019 issuance to date in this sector to a total of €14 bn.
Importantly though, with the exception of BNP, these deals are “pre financings” of current AT1s that are likely to be called later in the year.
This is important as when the sector opened in 2013, market participants have always been a little unsure of exactly what the banks’ intentions would be in respect of calling these securities on the first call date. The result of this was that sometimes bonds traded to a call date and at others they posed significant extension risk, which made them harder to manage from a portfolio risk standpoint. The consequence of this was that AT1’s have so far had a non-call premium embedded into their yield.
So what we can learn from the rush of fresh supply, and pre financing from the banks, is that most banks are treating these securities, and investors therein, seriously and generally not opportunistically. The reward for these issuers should be that the non-call premium is gradually eroded from the yield, giving these banks cheaper financing in the long term. It will also serve to create a steeper credit curve as bonds closer to call date start to trade as if they will be called and without the question mark of extension hanging over them. Even as recently as December last year, this question was still being asked by the market.
Naturally the economic back drop for the banks is favourable right now, so it is a lot easier for them to exercise their calls, therefore we must not take this for granted in all economic conditions.
Our view is that while they can facilitate calls without too much cost, most banks will do so. However, in the event that they face a recessionary environment with losses eroding capital and a much higher cost of refinancing, the banks probably should not be calling as they need that capital buffer, as this is what it was designed for.
For now though, this fresh supply in the AT1 sector should be viewed as good news and should encourage more investors into the sector.