Brexit lockdown stymies AT1 after Spring green shoots

The second quarter proved more constructive for Additional Tier 1 than had the mostly torrid opening months of the year, but although regulators did their part in bringing stability to the asset class, the positive sentiment was at first subdued and then dealt a body blow by the UK’s Brexit referendum.

The second quarter had opened with the market still riding the impact of the European Central Bank’s second wave of QE measures: the increase in the asset purchase programme’s monthly target from Eu60bn to Eu80bn, a new round of targeted longer term refinancing operations (TLTRO II), and a cut in the deposit rate.

After no AT1 had been launched in between mid-January and mid-March, in the US dollar market BNP Paribas followed on the heels of a UBS reopener and in April BBVA and Rabobank tapped euros. However, the recovery in sentiment after a turbulent first two months of the year was most strongly felt in Tier 2, where a steady stream of supply hit the market through April and May — albeit still subject to short windows.

The AT1 market itself enjoyed a last pre-UK referendum hurrah in euros as Erste Group Bank sold the first Austrian AT1 on 25 May. The Eu500m perpetual non-call October 2021 deal was the first subordinated issue from Austria since 2014 — during which Erste had missed a coupon on legacy Tier 1 — and came after the announcement of an agreement between the Austrian government and Heta bondholders. The deal hit a strong primary market to attract more than Eu2.25bn of demand from over 200 accounts, and was priced with a coupon of 8.875%.

The first semester nevertheless effectively ended a month early as the UK referendum loomed, with opinion polls increasingly showing a likelihood that the electorate would vote to leave —even if the market at the time of the vote failed to price in such an eventuality. Erste’s issue was the last AT1 in euros, while the last US dollar AT1 of the first half was an ANZ international debut on 6 June (see separate article).

“The whole market was in lockdown for Brexit for the whole of the month,” said Nigel Brady, credit financials trader at Crédit Agricole CIB. “The market then started to price in the fact that we would remain and obviously got massively caught offside — we were trading close to the highs in a lot of names and that’s why the move we saw was so large.”

Amid the wider sell-off in financial markets — not least of sterling — AT1 fell between five and 10 points, with UK and peripheral names being the worst hit. However, prices soon rebounded and the AT1 market emerged from the Brexit fallout relatively unscathed.

“Over the course of the week we got back pretty much all of the losses,” said Brady, “apart from the UK names, which were still trading probably three to four points lower than pre-Brexit. Core European names and peripheral names retracted all of the losses we saw on the Friday.”

Indeed, some market participants have been taken aback by how the fixed income markets had apparently taken the UK vote in its stride.

“In the past days, one has wondered how the market took the shock vote some 13 days ago,” said one syndicate banker. “Explanations have been given of good positioning going into the vote, well working hedges, half year-end, high cash balances, lack of street inventory, central bank support and stimulus expectations.

“Besides currency and yield predictions, most of the post-vote scenario analysis from research departments were wrong.”

Another market participant said that supply/demand dynamics help explain the supportive tone.

“Right now, people are struggling to find the paper that they really want to buy,” he said. “There wasn’t much paper around in the street and there was very little selling on the back of all the events.

“What you can tell from that is that there really is an underlying fundamentally strong demand for this sector.”

A new general election in Spain on Sunday, 26 June passed off relatively harmlessly as fears that the country could experience a similar political upheaval eased. Meanwhile, on the Friday the UK referendum result was announced, the ECB also revealed take-up in the first round of TLTRO II at the low end of expectations — sending mixed signals to the market.

On the regulatory front, the European Banking Authority on 1 July then addressed a key factor in the AT1 market’s turbulence early this year by following up on encouraging noises from the European authorities to confirm a split in Pillar 2 requirements that eases MDA calculation and hence coupon payment concerns (see regulatory section for full details).

However, in the first days of the second half UK risks began — using the expression of Bank of England governor Mark Carney — to “crystalise” and rumours that the Italian government would recapitalise its banks reached fever pitch (see Italy feature for more). The latest EU bank stress test results are due on 29 July and further ahead Italy is due for its own referendum, on constitutional change, in the autumn.

Political risk overall is expected to remain centre stage and cast a shadow over the market in the second half of the year.

“Everyone expects volatility to remain, what with the uncertainty on the macro-political side,” said Viet Le, financial institutions syndicate manager at Crédit Agricole CIB. “In the short term, I can hardly see where any positive triggers are going to come from to get us out of this prolonged period of volatility.

“We’ve seen some buying on dips of stronger names across the capital structure, but underlying volatility makes it difficult for investors to take a stance and position in the high-beta space, so in terms of issuance there I wouldn’t expect much in the coming weeks. You always want to stay optimistic, but given headline risk looming — Brexit/EU concerns, Italian banks, etc — expect a bumpy ride into year-end and consequently tight windows of opportunity for issuance.”