As deteriorating market conditions and rising rates have increased the level of extension risk in the Additional Tier 1 market, speculation has mounted around a series of call decisions approaching in the coming months.
Much of the discussion has centred on UBS Group's US$2bn 5% AT1, callable on January 31 2023. The bond stands out, as its 243.2bp reset spread is the tightest ever achieved on a European US dollar-denominated AT1.
The deal has traded below par for most of its life, reflecting investors’ expectation that it would be extended because UBS would be highly unlikely to refinance it on similar terms. The deal was bid at a cash price of 94.40 on Wednesday.
The bond came to be seen as the bellwether of a generation of AT1s issued during a period of relatively low yields and tight spreads. When it was issued late in January 2018, the yield of the Bank of America CoCo index hit what was then a record low of 4.35%, a far cry from its current 6.55%.
"When that one got issued in 2018, we all looked at it and thought 'that will be a fun conversation in five years' time', and here we are," said a DCM banker.
As the decision nears, however, some market participants now believe there is a relatively high probability that the bond is called.
Bankers and investors say UBS can afford to refinance the bond even if the exercise is uneconomical and reason that the bank may want to maintain its investor-friendly track record.
The decision from UBS’s domestic rival Credit Suisse to pay up to redeem a US$1.5bn 7.125% AT1 and replace it with a US$1.65bn 9.75% transaction in June – with the cost of the new issue heightened by the negative headlines surrounding the bank – may also set a precedent.
"The fact that Credit Suisse called and refinanced at a higher cost puts some pressure on UBS," said an investor.
"UBS have a large wealth management franchise and it is possible that some of those wealth management clients also invest in UBS's instruments, so it is a tricky case for them and they have to be careful of any potential reputational damage if they do not call this bond."
Defining 'economic'
A recent repricing in the AT1 market, if it continues, could move the needle sufficiently to make refinancing exercises more economical for issuers, bankers said.
“We have seen a pretty quick repricing in markets, particularly the AT1 market in recent sessions, and looking at the pricing for some issuers, it really has improved," said the DCM banker. "I suspect that for some of the calls that may have looked slightly tenuous or uncertain, levels have now improved.”
However, market participants stressed that many more factors can influence call decisions, as shown by the speculation around UBS, making predicting the fate of the current crop of calls a complex task. A second investor said that in the context of AT1 refinancings the exact meaning of the term 'economic' is open to interpretation.
"I think a fair proportion of the market just looks at reset levels, thinks about at what level a bank might issue a replacement AT1 and judges the probability on that basis," he said.
"I think that is too simplistic – there are other things that go into a bank’s analysis of what’s 'economic', not least the gains/losses on hedging and FX associated with any one particular AT1. On top of this, some banks also factor in the reputational cost of not calling (ie, in terms of whether this results in higher future financing costs), especially where AT1s have been placed into private bank or wealth management client bases, where these customers expect the bonds to be called."
Other considerations include the bank's flexibility to call their AT1s after skipping the first call date, depending on the frequency of subsequent calls, and the size of the bank's capital buffers over minimum requirements, which may allow them to call an AT1 without replacing it.
Market participants pointed to HSBC as a case in point. The bank announced on Tuesday that it will call its €1.5bn 5.25% AT1 at its September 16 call date – without having refinanced the deal.
"I think yesterday’s HSBC call announcement on its euro 5.25% was interesting, in that on the face of it, it would have looked economic to leave this outstanding (assuming it would need to issue a new AT1 at a spread above the reset on this bond), but there are undoubtedly other considerations (hedging, FX) that might make it economic to call," said the second investor.
Breathing space
Other decisions that market participants will have circled on their calendar include the December 15 call date of Raiffeisen Bank International's €650m 6.125% AT1.
The deal has a reset spread of 595.4bp, far wider than that of UBS, but is seen as a more likely candidate to be extended. It was quoted at a cash price of 86.50 on Wednesday.
For RBI, the task of issuing new AT1 would be far more complicated and expensive due to the bank’s significant exposure to Russia and Ukraine.
The conflict in Ukraine has resulted in a 50.3% fall in the Austrian bank’s share price year-to-date, while its subordinated bonds have also been hit hard. Its other AT1s are also trading well below par.
"The market will probably demand an issuer like RBI to pay a relatively chunky coupon, and it remains to be seen whether the CFO of the bank would be ready to concede this relatively chunky coupon," said the second investor.
Nearer on the horizon is the November 23 call date of Banco de Sabadell’s €400m 6.125% AT1, quoted at a cash price of 96.30.
The deal has a reset spread of 605.1bp, and investors said it would not be a surprise to see it extended, as the Spanish bank is unlikely to be able to refinance it on competitive terms.
"They could wait until the first week of October in theory to see whether the market improves from here," said a second investor. "It is fast approaching but they do have a bit of breathing space."