La Banque Postale set a new record low coupon for additional tier one capital in euros this week, at 3%. But as yields creep down, issuers are bidding farewell to the traditional specialist subordinated debt investors. More general credit and high yield funds are filling the void.
The minimum yield to place an AT1 bank capital issue in euros has ratcheted down slowly since Nordea set the record at 3.5% in 2017. Rabobank has broken it twice, hitting 3.25% and then 3.1% in April.
Now La Banque Postale has shaved 10bp off the previous record to price its second AT1 issue at 3%.
“It’s a great sign that in these current market conditions, banks can fund their buffers at cost-effective levels.” said Maxime Stevignon, head of France, Benelux and Switzerland fixed income capital markets at Morgan Stanley.
But more than the coupons are changing. “There is an underlying trend in the asset class, where AT1s are becoming a mainstream instrument across the real money community and especially for higher rated instruments, with a buyer base that includes more and more accounts, not just subordinated debt specialists,” said Matteo Benedetto, head of EMEA financial institutions bond syndicate at Morgan Stanley.
“The absence of some major UK investors was not a surprise at this level of yield, and we managed to attract some very high quality buy and hold demand elsewhere,” said Dominique Heckel, head of treasury, long term funding and repo at La Banque Postale.
Specialists spurn sub debt
For credit investors starved of yield, even a record low of 3% can look tantalising.
The worry for specialist sub debt investors who have spent a long time with this asset class is that while yields are edging down, so too are the spreads to which AT1s will reset if they are not called at the expected dates.
“The biggest question for me as an investor is: am I getting paid for the extension risk? When these deals come at record low spreads and coupons, you face the risk of an unattractive reset,” said Romain Miginiac, fund manager and head of research at Atlanticomnium.
La Banque Postale’s note will reset to a spread of 312.1bp over five year mid-swaps if it is not called between November 2028 and May 2029.
For comparison, its debut note, issued in November 2019, will reset to a spread of 401bp after November 2026, if not called.
“With this new wave of issuance, be it in dollars or euros, we are starting to get to a point where the back ends are around 300bp, down from 400bp,” said Miginiac.
“At this point in the cycle, when everything is great, people don’t care, but if the market were to turn, the instruments with the lower back ends will get hammered as investors realise that when holding to perpetuity, 3% does not look that great,” he added.
“For specialist investors like myself, we’ve seen how the instrument responded in 2020, 2018 or 2016,” said Sebastiano Pirro, portfolio manager at Algebris.
“We know that when things normalise, a bond with very poor convexity tends to underperform. Knowing this, when you have the choice in this environment to choose similar yield product with a better back end, you’d have to be mindful when choosing the lower one.”
Miginiac added: “Why take on the extension risk, when you can stay in an existing instrument without giving up spread?”
“I think this is a trend for the frequent, good quality issuers, but we might still see high levels of specialist involvement in the higher coupon or higher beta deals,” said Stevignon.
Posting new lows
La Banque Postale marketed its perpetual non-call 7.5 year AT1 through Barclays, BNP Paribas, Morgan Stanley, Natixis, UBS and its own investment bank on Wednesday morning.
“The market opening on Monday was weak, hence we decided to delay the launch of the transaction,” said Heckel. “Given a more volatile backdrop this week, we also decided to use an intraday execution, instead of a two-day execution, which would have included one day of marketing.”
The leads started the sale with initial price thoughts in the 3.375% area, aiming for a benchmark size in euros.
They proceeded to chop 37.5bp off the coupon at one blow and directly fixed it without any more revisions.
“Given the strong psychological barrier at 3%, we wanted accounts to know we were not testing inside 3%,” said Benedetto.
Backed by over €1.4bn of peak demand, the borrower raised €750m.
“When looking at our secondary level and recent execution dynamics, it is true that we had in mind to set a new record with a 3% coupon, or potentially slightly inside,” said Heckel.
The comparable bonds pointed to a fair value in the context of 2.85%-2.95%, said Thibault Archeray, co-head of FIG debt capital markets at Natixis. “Relative value is one element, but the absolute level was also key in this transaction. The 3% threshold was a psychological barrier for many investors in the book.”
“The deal comes at a time when the financing conditions for issuers, especially in subordinated debt, are extremely attractive,” said Miginiac. “We’ve seen issuers go a lot further down the curve: non-call seven or eight is now the norm, when before the five year call was dominant.”
Breaking the price barrier
“I remember having similar discussions when HSBC sold a euro AT1 at 4.75%, and whether someone could go below that,” said Miginiac.
The room for further performance in AT1s could help a “best-in-class European credit” dip below the 3% barrier, said Archeray. “The AT1-tier two spread still feels wide — especially for highly capitalised banks with very low MDA risk.”
The maximum distributable amount (MDA) is a regulatory threshold that prevents banks paying coupons on AT1 if they go below or plan to dip below their combined buffer capital requirements.
“You have candidates that could on paper go below this 3% threshold," said Benedetto, "but the question for me in the syndicate seat is: does it make sense to break this barrier as opposed to going longer and staying above 3%?”
While AT1s in the euro and dollar markets have set respective new lows of 3% and 3.75% over the last month, the instrument has gone even tighter in other currencies.
Miginiac pointed to the Swiss franc market, where the cantonal banks have priced with coupons as low as 1.5%.
“People like to say they can’t go below a point," he said, "but as long as we’re in a market where senior bonds offer almost nothing, some investors will see this as attractive.”