Wells Fargo's plunge into the perpetual preferred market was rewarded with strong demand on Monday, marking the first Tier 1 capital transaction from a US lender since the failures of Silicon Valley Bank and other regional lenders in March.
When regional banks came under pressure, preferred instruments were among the hardest hit in the bank bond market. Yet, in recent weeks tightening credit spreads, signs of ebbing inflation and an easing of concerns around the financial industry have helped push down yields for existing preferred notes, creating an opening for Wells Fargo's new deal.
In the end, the offering drew more than US$6bn of demand. Market participants say the success of the Baa1/BB+/BBB rated deal could pave the way for other US banks looking to raise regulatory capital through perpetual notes.
Throughout the dislocations in the regional banking sector since March, bonds from the biggest US banks have stayed resilient. Analysts have pointed to customers taking their deposits away from the smaller banks and moving them to their bigger counterparts as one reason why investors are confident about the health of global systematically important banks.
“Based on what we’ve seen from deposit flows, there’s clearly a view that the G-SIBs are not under the same kind of concern as the regionals,” said Nicholas Elfner, co-head of research at Breckinridge Capital Advisors.
After setting initial price thoughts for the SEC-registered offering in the 8.125% area, Wells Fargo tightened the US$1.725bn transaction by 50bp to land it at 7.625%.
The steep price progression was more than some had expected. Before the offering was launched, Dan Bruzzo, a managing director at Santander US Capital Markets, saw the new notes landing at around 7.70%–7.80% based on where other preferred notes were trading. He compared the Wells Fargo deal with Citigroup's recent preferred issue in February, a US$1.25bn 7.375% perpetual non-call five transaction that traded at a yield-to-call of 7.57%.
A financial industry banker said the biggest and strongest US banks would contemplate more perpetual preferred issuance in US dollars when existing notes were trading with a seven handle.
The banker also said financial borrowers would sell more dollar-denominated subordinated paper when they felt inflation had cooled down and there was broader acceptance among market participants that the Federal Reserve was near the end of its hiking cycle. The weaker-than-expected June inflation data helped support that view, said analysts.
European and Asian banks have already sold a few Additional Tier 1 offerings in their home currencies in recent weeks as global investors have grown more comfortable buying the instrument.
But some question whether other US lenders, especially the smaller regionals, could attain the same investor reception received by Wells Fargo.
“It’s case-dependent," said David Knutson, head of US fixed-income product management at Schroders. "Preferreds [for the regional banks that failed] got wiped out. You’re going to see a pretty stark contrast in market access between the larger banks and the smaller regional banks.”
Fixing the cracks
Proceeds from Wells Fargo's preferred transaction are expected to refinance its older notes that will not shift to SOFR. This is despite the passage of the Libor Act in 2022 that was intended to help replace Libor in legacy financial contracts without clear provisions for a replacement reference rate.
CreditSights analysts pointed to its existing US$1.725bn 5.85% preferred note issue callable later in September as a prime candidate for the refinancing.
Those notes were among the handful of legacy Libor-based preferred deals that did not have language allowing them to switch to SOFR when they reached their first call date. Instead, coupons for those older notes will become fixed for life.
Besides aiding its transition away from Libor, a refinancing would lower the bank's interest costs. Under the current offering structure, the 5.85% preferreds will change on September to a fixed coupon of 309bp plus the prevailing three-month Libor rate, equivalent to a coupon of around 9% now.