UBS unlocks market as AT1 steps back from brink

UBS breathed life into the Additional Tier 1 market on 14 March with the first such issue in more than two months, making a move to sell a $1.5bn AT1 that was bold even if the asset class had been a beneficiary of European Central Bank measures that lifted credit markets.

Only a few days earlier the new issue would have been all but unthinkable, after a disastrous start to the year for the AT1 market. Intesa Sanpaolo and Crédit Agricole were able to launch euro and dollar benchmarks, respectively, on 12 January, but the market subsequently shut down, initially on the back of macroeconomic worries and then as a result of issues central to the asset class.

New year equity and credit markets were spooked by sharp falls in the oil price that took it to the first of several new lows, while concerns about Chinese growth added further downward pressure. The volatility left the financial institutions market — with the exception of covered bonds, but including insurance — increasingly moribund as January progressed into February.

Into this cocktail of negative exogenous headlines came bad news from the financial sector itself, with concerns growing over bank results leading to fears that some issuers might be restricted from paying coupons — particularly with the European Banking Authority having in mid-December apparently raised the bar for making such distributions (see separate article). The resulting deterioration in sentiment hit credits from the periphery to the Nordics, although Deutsche Bank found itself centre stage (see separate article).

The sharp fall in the AT1 market on the back of the fears over non-payment of coupons was compounded by concerns that, as prices fell, the likelihood of the instruments being redeemed on their first call date — which, like coupons, is a discretionary feature of AT1— fell.

“What that does is cause some negative gamma in the whole sector because the further away you move from par, the less likely they are to be called,” said Crédit Agricole CIB credit financials trader Nigel Brady. “If you flip from pricing them to a call date — i.e. you are going to get your notional back in five years’ time — and start pricing them as a longer term perpetual, they actually become a lot more expensive at the margin.

“That is the kind of dynamic we saw in February. Indeed, there were several factors conspiring against the sector, which is why we fell between 10 and 20 points broad-based between January and mid-February.”

Exacerbating the pressure on prices was, according to various market participants, the liquidation of positions from among the biggest holders of AT1.

“There was some capitulation selling due to outflows from specific funds,” said one, “and that caused yet another very negative dynamic for the whole market just when it didn’t need it.”

Headlines about a CoCo “death spiral” soon emerged in the wider press amid warnings that the risks afflicting the AT1 market could contribute to dragging the European banking sector back down to the darkest days it suffered during the financial crisis.

ECB changes the game

Credit markets and AT1 prices improved in the second half of February, but it was not until the “game changer” of the ECB measures on 10 March that market participants considered sentiment suitably constructive for a reopening of the bank capital market. And while senior and Tier 2 issuance revived in the wake of the central bank meeting, it was UBS that stole the headlines with its AT1.

The Swiss bank attracted over $8bn of demand to its $1.5bn perpetual non-call five issue, with the level coming in from initial price thoughts of 7%-7.125% to 6.875%.

“Consider this,” said Eoin Walsh, partner and portfolio manager at TwentyFour Asset Management, “the same group of investors that were reluctant to buy the old UBS AT1 at a yield of over 9%, and a price of 85.0, just a few weeks ago, pumped over $8bn of orders into the new, $1.5bn deal, which was only paying a coupon of 6.875%. Such is the power of the sentiment change.”

While he acknowledged the strength of post-ECB price moves as a factor in the market’s recovery, he also attributed it to other encouraging central bank comments, strong bank results and a Deutsche Bank senior buyback.

“However,” he added, “the biggest factor was probably the realisation that the yields on most AT1s were pricing in scenarios that were highly unlikely and were giving scant regard for the capital strength of most European banks, and creating some of the best opportunities seen in years.”