Hope, but less fantasy after March inflection point

New issue premiums rose sharply and oversubscription levels shrank as the credit markets hit an inflection point in mid-March, but as oversupply and volatility eased into April, bright spots in AT1 held out the promise of a more constructive primary market — albeit with the QE-inspired buying frenzy consigned to history.

HSBC image

Credit markets had already turned softer in February, alongside equity market weakness and volatility that was in turn prompted by stronger employment and inflation figures in the US, raising fears of quicker than expected interest rate rises in the US and a potential accelerated end to unconventional monetary policies in Europe.

The renewed bout of difficulties in mid-March were then caused by endogenous factors, namely oversupply and its impact on pricing: an aggregate EUR28bn of FIG supply hit the market across the capital structure in the first two weeks of March, as issuers sought to issue before conditions deteriorated further.

“Everyone recognises that what we have been enjoying for the best part of a decade is over now,” said Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB. “The headlines have not necessarily changed dramatically, but the perception of their impact on the capital market spread complex is evolving because performance is very disappointing across the board.

“US politics and growing concern over a trade war, an acceleration of interest rate rise, TLTRO refinancing, Italy, Brexit, forthcoming MREL numbers… There are so many uncertainties which have been ignored because fundamentals are excellent, but the buying frenzy has now left the room.”

Meanwhile, even after the widening in February, valuations continued to be viewed as rich, with absolute levels still being attractive for issuers on a historic basis and tight relative to other asset classes.

“Generally speaking, the current market conditions are more favourable to issuers than to investors,” said Stéphane Herndl, senior credit analyst, research department, La Banque Postale Asset Management (LBPAM). “In this context, the low new issuance premiums do not compensate for the higher embedded extension risk of the latest AT1 vintage — the latest AT1 have been printed with very low back-ends of less than 400bp if not 300bp for core European banks. Finally, the pick-up offered by recent deals does not compensate for the longer distance to call.”

“Since October 2017, the AT1 asset class has outperformed the high yield corporate asset class,” added Guillaume Fradin, senior portfolio manager, fixed income and credit, LBPAM. “The yield differential between the two has narrowed, making the investment in AT1s less compelling versus Euro high yield instruments.”

The result was that the “keep calm and carry on” camp capitulated in March on the back of the oversupply and secondary market underperformance, according to Hoarau.

“New issue concessions increased significantly in March, with issuers exacerbating the situation by rushing to market pre-Easter in weak markets, and we saw lower oversubscription levels in primary,” he said.

Hefty NIP for HSBC $4bn

In the AT1 market, the new conditions were exemplified by a US dollar issue for HSBC on 19 March. The UK-headquartered bank had said the previous month that it would itself be issuing up to $7bn of AT1 this year and its March issue took out more than half of this.

It went out with a two-tranche deal, rated Baa3/BBB, comprising perpetual non-call five and perpetual non-call 10 tranches with initial price thoughts (IPTs) of the 6.375% area and 6.625% area, respectively. The issuer ultimately took $4bn out of the market, sizing the non-call fives at $2.25bn and the non-call 10s at $1.75bn, but only achieved pricing in the middle of guidance set an eighth inside IPTs, at 6.25% and 6.5%, respectively.

“The issuer paid a hefty 50bp new issue premium to get the size,” said a syndicate banker away from the leads. “You would have thought something like this would have been a slam-dunk for HSBC in dollars, but it looked like it was actually a relative struggle.”

Although the signs that the market was being more sober were there from February onwards, only a week before HSBC’s trade, conditions had been more accommodating, even if the bullish sentiment of the first weeks of the year had passed: on Monday, 12 March, Santander launched the first benchmark AT1 from a European issuer since 25 January — when Belfius had sold a EUR500m debut — and the Spanish national champion was able to attract some EUR5bn of demand to its EUR1.5bn deal.

After announcing a mandate on 1 March, it went out with a perpetual non-call seven AT1, rated Ba1, and following IPTs of the 5% area was able to achieve pricing of 4.75%. According to lead manager Santander, the coupon is the lowest ever on an AT1 for a southern European issuer. It was also 50bp inside the issuer’s last AT1, a EUR1bn perpetual non-call six in September 2017 priced at 5.25%.

Compatriot CaixaBank followed with its own AT1 the next day, after having been monitoring the market for some time but decided to allow its larger peer to go first following its mandate announcement, according to a syndicate official at one of CaixaBank’s leads.

CaxiaBank was able to attract almost EUR3.5bn of demand to its EUR1.25bn AT1, and tighten pricing from IPTs of the 5.5% area to 5.25%.

A syndicate banker said that, given how the market developed afterwards, it was a relief to have gotten the deal done.

“Literally the next day the proverbial hit the fan,” he said. “Had we waited an extra day it would have been a bit of a nightmare.”

A two week hiatus including the long Easter weekend followed HSBC’s $4bn trade, before Société Générale on 4 April launched the next benchmark, a $1.25bn perpetual non-call 10 AT1. The French bank went out with IPTs of the 6.875% area before pricing the transaction, rated Ba2/BB+, at 6.75%, which a banker said was equivalent to a new issue premium of around 37.5bp.

Second tier cheer from Ibercaja

Ibercaja had meanwhile shown how smaller and juicier trades could avoid the worst of the pricing demands being placed on issuers, when it tapped the market with a debut, EUR350m perpetual non-call five AT1, rated B-/B, on 27 March. The issuer combined paying one of the highest coupons of any outstanding euro AT1, 7%, with paying a much lower new issue premium than larger and better-rated paper.

“Unlike many other previous AT1 issuers, Ibercaja managed to only pay a marginal 1/8 new issue concession, despite the market backdrop,” said a syndicate banker at one of the leads. “Beside credit quality, the ability to leverage on limited size needs and a higher reset allowed the issuer to price their EUR350m deal on the back of a more than 2.7 times oversubscribed book and a coupon of 7%, from the low to mid-7% IPTs.”

The Spaniard’s success was to some extent mirrored by Deutsche Pfandbriefbank (pbb), when it two weeks later priced an inaugural AT1. The German bank priced its EUR300m perpetual non-call five, rated BB-, at 5.75% on 12 April on the back of some EUR900m of demand, following IPTs of the 6% area and guidance of the 5.875% area.

The success of such deals were deemed a good omen for Bawag Group, which on 12 April announced a roadshow for a EUR300m no-grow perpetual non-call seven inaugural AT1, with an expected rating of Ba1.

“Except for a few well-flagged core AT1 issuers, European G-SIBs have filled — or are close to having filled — their AT1 buckets,” said Herndl at LBPAM. “Net supply will therefore be limited to new issuers, i.e. second tier banks. As evidenced by recent deals, current market conditions are favourable to issuers.

“This is supportive for smaller Spanish banks, for example, which would otherwise not have been able to tap the market and beef up their regulatory solvency. Conversely, the ability to issue AT1s for second Tier Italian banks remains more challenging in our view, given the SSM’s pressure to reduce NPLs and lagging economic recovery compared to that of Spain.”

Syndicate bankers are cautiously optimistic that wider conditions may also prove more constructive for bank capital issuance in general, particularly with black-out periods in April and a slowdown in supply helping stabilise the secondary market.

“But after a difficult month of March for investors, the level of diligence remains high and investors’ involvement in primary is dependent upon the promise of secondary performance,” according to CACIB’s Hoarau. “Subsequently, new issue concessions remain at an elevated level and issuance windows short.

“The situation won’t change until a new equilibrium and pricing paradigm is found. We also need more visibility on the rate direction and the modalities of tapering.”