A year ago multilateral development banks issuing hybrid capital sounded like the Pope going out in a clown costume. Now public sector bond bankers can talk of nothing else.
Not for the first time, innovation has been led by the African MDBs — Trade and Development Bank, Banque Ouest Africaine de Développement and the African Development Bank. Credit to the rating agencies, too, which got criteria ready some time ago.
But the dossier has been slapped on boardroom tables from Washington to Manila by the G20, whose independent panel on Capital Adequacy Frameworks reported in July 2022, arguing there was room for a huge expansion in MDBs’ balance sheets. Hybrids went from dangerous toys to badges of virtue.
Suddenly MDBs from the World Bank to the European Bank for Reconstruction and Development are jumping to attention. The former is selling hybrids privately to shareholders — both plan pilot public deals.
But the starring part is being played by the AfDB. First of the triple-A rated MDBs to announce a public hybrid bond sale to investors, it has been marketing it since July.
Pride or prudence?
What everyone wants to know is: where is the deal?
Bankers say there has been lots of interest, they are just waiting for the right market.
It’s clear the AfDB is sensitive about pricing. It wants the spread to reflect its superb credit quality and loyal backing from shareholders, which mean it is extremely unlikely ever to have to write down the instrument. GlobalCapital’s well informed hunch is that it is looking for something in the 100bp-150bp range over senior debt.
That would be in the right ballpark for a corporate hybrid of this rating, if any existed. But those carry 50% equity credit. This is a 100% equity credit security, more like bank additional tier one capital. And those trade in a different time zone, more like 400bp over senior.
MDBs are not commercial banks. A big part of the AfDB’s loans are to governments, at low, concessional interest rates. They also do not have to pay shareholders dividends. And they can use other techniques to free up equity, such as securitization and insurance.
So there will be a spread level at which a hybrid is just too expensive for an MDB: the cost would outweigh the benefit.
But short of that point, the AfDB, and its brethren in the sector, should be willing to swallow a lot of hurt pride and irritation to get these securities into the market.
The price of newness
Only the Bank itself and its lead managers know the indications of interest they have. There is likely to be a wide spread of price views, since this is a completely new instrument an investor can analyse in many ways.
The central truth is: coupon suspension or writedown is obviously unlikely, but exactly how improbable no one can calculate — investors just have to take a view. There are glass half full people out there, and glass half empty ones.
But if a deal can be done at a viable level, even if the spread feels insulting or the note has to be smaller than hoped, MDBs should grab it.
It is likely that many of the potential investors are being obtuse. Some AT1 specialists, for example, have fretted that MDBs don’t have a regulator, as if that made the security less reliable. Perhaps they fear the AfDB might shout “tricked you!” and write down the bond. This is preposterous. Haven’t these investors noticed the MDBs are the most conservative bunch of banks on the planet?
But these misunderstandings will be rubbed away once the asset class gets going. Investors will come to understand the sector better and MDB hybrids will develop their own cloud of reassuring, orthodox opinions.
Remember when bankers couldn’t work out whether green bonds should price tighter or wider than normal bonds? Now the greenium is settled science.
For this to happen, though, the market needs to begin. Good things come to those who don’t wait.