European banks were more than happy to extend the life of their additional tier one (AT1) paper for economic reasons during the volatile early days of the coronavirus pandemic.
And now, almost three years later, Europe faces yet another crisis. Interest rates and spreads are moving up and wider, dragging bank funding costs with them as the continent faces recession.
Just over a year ago, banks were pricing AT1s in euros with coupons as low as 3% but today they would be lucky to land a bail-in senior note anywhere near that level.
As a result, the levels to which coupons reset after the first call date on many AT1s are now far below what banks would have to offer for a new note.
For instance, next year’s forthcoming calls on Yankee bonds are set to reset to an average implied yield of 8.38%, almost 100bp lower than where BNP Paribas and Société Générale issued new dollar notes last month. And even then, this pricey dollar level was still cheaper than its equivalent in euros.
But for now, larger banks appear happy to pay up to keep their sizeable bond investor bases happy.
However, there is still a red line for issuers at which point printing new, more expensive debt becomes hard to justify. Larger firms might swallow the excess spread with gritted teeth to please their investors, but for smaller issuers those extra basis points represent a sizeable leap in their funding costs.
A handful of second and third tier firms have AT1s up for call next year, including one which struggled to refinance a tier two note earlier this year. Although bond investors might see extending as a sign of weakness, in this uncertain market — where costs are rising — leaving the debt on the balance sheet could just be the prudent thing to do.