The brutal repricing of credit markets looks to have shut off access to new subordinated debt and hybrid capital at economic levels for some of Europe’s second-tier and non-prime banks. Given that the ingredients of the toxic mix of rising interest rates, global energy crisis, war in Ukraine and deteriorating global economy show no signs of disappearing quickly, this is where the market is likely to stay for some time.
As such, European regulators need to pay serious heed to this predicament and come up with an urgent solution, perhaps by rethinking guidance or even rejuvenating the capital instruments toolkit as an issuer’s inability to raise capital to meet regulatory requirements, simply because it’s been priced out of the primary market probably wasn’t in the European Central Bank (ECB) or European Banking Authority (EBA) playbooks. But these could have knock-on effects on the stability of the European banking sector.
Comparing the coupons that European national champions were paying on additional tier-1 (AT1) trades in recent weeks with what they were paying in 2021 and early 2022 shows how far the market has moved.
Société Générale (SG) US$1.5 billion, BNP Paribas (BNPP) US$1 billion and Deutsche Bank (DB) €1 billion (US$1.04 billion) all tapped the AT1 market in November with calls at or around the five-year point. DB paid 10% in euros while BNPP and SG paid 9.25% and 9.375% respectively in US dollars in recent days. Contrast that with the 3% and 4% handles those banks and any number of other national champions and prime banks – Barclays, Crédit Agricole, HSBC, ING, Nordea, Rabobank, Santander, Standard Chartered, UBS and UniCredit – were paying to get AT1s away in 2021 and early 2022 before Russia’s invasion of Ukraine demolished market sentiment.
Gauging the true extent of market repricing for non-prime lenders is, like all credit pricing, a matter of art rather than science. But in high-beta markets like AT1, it’s fair to assume that the lower down the seniority spectrum you go, the larger the spread swing factor is relative to prime banks. Working out where a second or third-line lender can price hybrid or subordinated capital is a matter of taking the magnitude of difference between prime bank levels and adding in a swing factor on top of that.
How big a swing factor will depend on market windows opening and closing as sentiment switches back and forth between risk-on and risk-off. Irish second-line lender Permanent TSB (PTSB) has drawn some sort of a line in the sand. The second-tier Irish bank paid 7.875% on its AT1 in November 2020. On its most recent foray into the market in October 2022, it paid 13.25%.
In a cautious investor-driven market, where banks need to maintain reasonable headroom above minimum capital requirements to meet investor approval (and remaining sufficiently far away from so-called “maximum distributable amounts” that require regulators to restrict coupon payments if banks breach combined buffer requirements), the swing factor could be much higher than the PTSB differential suggests.
Banks in other eurozone periphery countries have also drawn lines in the sand. Greece’s Piraeus Bank priced a €350 million four-year senior preferred bond with a three-year call in mid-November with an 8.25% coupon. The same bank sold an AT1 in June 2021 with a coupon of 8.75%, which had recently been trading to yield north of 16%.
In a similar vein, Portugal’s Banco Comercial Português (BCP) paid 8.5% on a three-year senior preferred offering in mid-October with a two-year call; BCP’s AT1 of January 2019 has a coupon of 9.25%. That instrument is marked in the mid-80s yielding close to 12%
Other pressure signs regulators should be paying very close attention to signalling the extent to which banks have been priced out of the market is the number of banks opting to extend tier-2 bonds beyond their first call dates. In recent years, this practice has been almost unheard of.
BCP announced on November 22 that it would not call its €300 million tier 2 at its one-time December 7 call date so the coupon will reset from its current level of 4.5% to 426.7bp over five-year swaps, which equates to around 6.9%.
In the same announcement, BCP launched an offer to exchange the outstanding notes for a new minimum €125 million 10.25-year tier-2 line with a call at 5.25 years with an 8.75% coupon. The new line offers investors some sort of concession while giving the bank capital at a compromise cost: market consensus for BCP to get a new tier 2 away is around 11%.
As long as the market remains prohibitively expensive for non-prime banks, issuers will likely seek some sort of compromise solution rather than leaving investors high and dry with non-calls. But this is hardly ideal. The ECB and the EBA need to act now before serious damage is caused.