BBVA: Capital strategy rewarded

Banco Bilbao Vizcaya Argentaria took advantage of the improvement in market conditions in the first quarter to attract strong demand for AT1, Tier 2 and senior non-preferred at minimal new issue premiums. Bank+Insurance Hybrid Capital, in association with Crédit Agricole CIB, spoke to the Spanish bank’s funding team about its strategy, and its views on the latest market and regulatory developments.

BBVA La_vela_bbva

Bank+Insurance Hybrid Capital (BIHC): You have been very proactive in building up the capital stack of the funding plan in Q1 while boosting the bank’s flexibility when it comes to refinancing previous AT1 issues. What were the drivers in the decision process with regards to the timing of the SNP, the Tier 2 and the AT1 transaction?

BBVA: The market was not very positive in the last part of 2018, and then in January — even though we saw some issuers tapping the US dollar market for very large amounts — there was high volatility, with prices far away from the last deals that were executed. For example, a senior non-preferred issue for us in January would have been like 80bp wider than what we saw in the last period of stability. We took this into consideration and decided not to tap the market in January but to delay any execution.

At the same time, we have this year a funding plan that envisages the execution of several deals, so when we saw in February a general improvement in market conditions we tapped the market with the Tier 2. This was the first transaction we wanted to execute, because we were facing the call option of the 10 non-call five that we issued back in 2014, and this new issue was partially refinancing the execution of that call option. That is why we announced this first Tier 2 transaction in February at more or less the same time we were announcing the notice to bondholders of the call of the former Tier 2 transaction. These were a couple of factors in our decisions.

The only transaction we feel we accelerated to some extent was the AT1, because the senior non-preferred was a transaction that, frankly speaking, we had wanted to execute in the last part of 2018, but — as I said before — market conditions were not that supportive.

We took the decision to proceed with the AT1 because we have a call option next year — for EUR1.5bn on the transaction we issued in 2015 — and we thought that the best strategy to try to refinance that transaction and be able to execute the call option was to split the refinancing into a couple of tranches. As with all instruments, we have an economic policy regarding AT1 calls, but the difference with this instrument is that reset spreads in terms of euro basis are very volatile and you can face very different situations. Even though we were anticipating the call date almost a year in advance and there is therefore a large cost of carry as we are maintaining the two securities for almost 11 months, we thought that this was the right point in time because in terms of back-end spread we were saving around 56bp, which is quite a lot if you take into consideration the structure of these transactions.

BIHC: Were you satisfied with the results and the make-up of the different order books?

BBVA: We were positively surprised at the outcomes of these last three transactions. We are not a massive issuer in terms of volumes and we normally spread out the execution of different transactions over the year, whereas here we were executing three transactions in the euro space in a period of just 40 days, but still had a lot of traction on each.

In the first one, the Tier 2, we were kind of cautious about what the right pricing for this instrument would be, given that there had not been much supply during the last months. So we were very prudent, and ultimately we got very strong traction in the book, which peaked at approximately EUR4.5bn. Then we executed the senior non-preferred and the five year maturity proved to be the sweet spot because it also drew almost EUR4bn of demand. And lastly, the AT1 had final demand of approximately EUR3.5bn.

Not only were the books oversubscribed, but also the composition of demand was pleasing. For example, if we compare the AT1 book with the one we got in September 2018, the presence of asset managers has increased materially — this time it was around 80%, which is very high. Geographically, in general we enjoy strong support from France across all products, and specifically from the UK in AT1. Germany is also supportive and Spain, increasingly so. We were also delighted by the granularity of orders, which numbered more than 200.

Additionally, in these transactions we were able to tighten pricing substantially, and the final pricing of all three was close to fair value. The fact that our new issue premium was almost zero reflects the quality of demand and the good momentum in the market.

BIHC: The five year BBVA SNP launched in February is trading flat to French peers — this would not have been expected a year ago. How do you explain this result?

BBVA: We benefit from some effects that are positive to BBVA. The first is that we profit to an extent from some scarcity value. In terms of MREL, we do not need to raise massive amounts as we are not a globally systemically important financial institution — we just face the MREL requirement, not TLAC. We therefore do not need to raise massive amounts of senior non-preferred — we are raising EUR2.5bn-EUR3.5bn a year, which is not that material, and we can split that into two or three transactions. I believe this is very well understood by the market, which is good for us.

Secondly, we have profited from the work that we have done in servicing and meeting the investor base. In these last three deals we have been very active in visiting investors and exchanging ideas.

And the third factor I would like to highlight is that we have been very transparent about our plans to tap the market. For example, on the last AT1 we were very clear in saying that there may be a second AT1 transaction being executed this year. This is, I think, very valuable for investors to know. We are also transparent about our strategy regarding call options, where investors can see that we are working in advance to prepare for these. There is some discrimination among investors towards issuers in this regard — issuers who are doing their homework and getting the authorisations in advance, versus those who are taking last minute decisions — and in the long term the kind of strategy we are following pays off, even if sometimes the market values this more than at other times.

BIHC: Did you get investor feedback regarding the call period of your AT1 following the first call date?

BBVA: We have had a lot of feedback on this issue, although it did not affect the execution of the transaction.

During recent investor meetings — not only in Europe, but also in the US and Asia — it has been a topic that we have raised, since Spanish issuers have, let’s say, non-standard quarterly calls, which are an outlier compared to the European standard. There is not a uniform view on this among investors. Some say that they face constraints in hedging such bonds and in valuing them when they are not called — this tends to be a view more among UK investors. But we also have some positive feedback. We had this example of Santander being the first issue not calling an AT1, and a positive effect of the quarterly calls was that the bond did not fall so far in value, because it could be called in the next quarter. That is the first advantage, and a second is that having quarterly calls means that the probability of the bond being called is higher — that is just simple mathematics.

Although there are different opinions among investors, even those who see the quarterly calls in a negative light are not declining to participate in our deals — they simply say that as long as they are granting this extra optionality to the issuer, they may take that into account in their pricing expectations. Our most recent AT1 had exactly the same terms and conditions as when we launched the first under CRD IV in 2013 — we haven’t changed the call period — and the investors were all there in the book, there was no impact on the size or price for BBVA.

BIHC: BBVA has already called two AT1 bonds and was the first European bank to do so. How did you approach the economics surrounding the refinancing of the notes? What is the economic tolerance the regulator will give when it comes to economic calls? What tolerance do you use internally to judge economic calls?

BBVA: We have indeed executed a couple of call options and there have been no hard guidelines from the supervisor in this regard. You have to demonstrate your rationale when requesting authorisation to call and there is a section on the economic implications of the call. What we would like to highlight is that BBVA is of course following an economic policy when it comes to call options — and that is widely understood by the market — but there are still two ways in which we have some flexibility. The first is that we can anticipate any call option by prefinancing it, as we have demonstrated previously and again this year.

Secondly, we can combine currencies, which is a strategy that has been excluded elsewhere. We do not believe that you should combine only euros with euros and dollars with dollars — that is not necessary. If you execute a transaction denominated in euros or dollars, it is because you have exposures, risk weighted assets, denominated in these currencies — you have this natural hedge between the numerator and the denominator of the capital ratio. So if we have RWAs denominated in dollars, we can issue AT1 denominated in dollars because it naturally hedges those assets, and that is what needs to be taken into consideration. So if we face a euro call option, for example, where it is not economic to refinance it in euros, it could be the case that we consider refinancing that in US dollars if it makes sense from this hedging perspective. And if you can combine currencies thus, that makes a big difference.

BIHC: Do you think liability management on AT1 within the first five years of the instrument will become more common once CRR2 is implemented? Could the tender and exchange of the recent Coventry be an example of how issuers can smoothly transition an AT1 call?

BBVA: This is a very interesting question. We fully agree that this a topic that is now up for debate. However, it is not new — we have been reviewing precedents and found, for example, one regarding Austrian issuer Bawag, which last year did this kind of amortisation before the fifth anniversary of a Tier 2 transaction. So we have a precedent in the euro space and not only in the UK with the Coventry transaction.

It makes a lot of sense. Once the new draft of CRR2 and the changes regarding Article 78 are formalised and approved, we foresee having additional flexibility to minimise the cost of carry. For example, if we had this possibility now we could be offering some kind of liquid exit on those bonds that will probably be called in the future, and that would reduce the cost of carry substantially. It would have to be considered as a liability management exercise, not as amortisation of capital. And it would need to be of benefit to both parties, with investors having a liquid exit where they can reinvest the proceeds in another security, and with the bank being able to reduce the cost of carry. So yes, I think it may become very common.

BIHC: Do you think we will see even more standardisation in AT1 structures going forward?

BBVA: Many people are expecting a review of the different Tier 1 instruments in general — not only regarding call frequency, for example, but deeper aspects that are much important, such as the level of the trigger. Some regulators have said publicly that the 5.125% loss absorption trigger is so much out of the money in terms of current capital ratios that an instrument that was initially designed as a going concern tool, to absorb losses before resolution, ultimately seems to be a gone concern instrument, like Tier 2, in the sense that losses are absorbed as resolution is taking place. So this instrument will definitely be reviewed in the future, with a deep review of every feature, but right now supervisors are focused on loss absorption triggers.

You have a precedent there: in the UK, for example, you have the 7% level which is defined on a fully-loaded basis. And unfortunately we have seen what happens in practice, with an AT1 absorbing losses and being converted into shares in resolution when the point of non-viability is called, rather than at the 5.125% trigger, which is so theoretical.

BIHC: As other European banks increase their capital target and CET1 stock, do you feel pressure to reinforce your capital structure?

BBVA: There is no pressure, but we have decided from our side to increase the capital target.

That we do not face any pressure is demonstrated, firstly, in the SREP requirement, the official requirement set by the ECB for European banks, taking into consideration not only CET1 but also the Pillar 2 requirement: our SREP requirement has been the same for the last three years in a row. It has not been increased. First thing.

Secondly, in the latest published results of the EBA stress tests, we enjoyed a couple of very positive outcomes. The first is that in terms of CET1 fully-loaded depletion, we had one of the lowest figures among our European peer group. The second is that we were one of the few banks that managed to make profits even under the stress test’s adverse scenario.

We have taken the decision to increase our capital target on a voluntary basis for one reason, which is to anticipate forthcoming regulatory changes, mainly Basel IV. Even though we do not expect the impact of these various regulations to be material for BBVA — because we have a very high capital density and make very limited use of internal models — it is good for us to move to our new, higher target level of 11.5%-12% on a voluntary basis. As was announced alongside our full-year 2018 results, we expect to achieve the lower end of this range the end of 2019.

BIHC: How do you manage and set the capital targets and buffers internally?

BBVA: It’s a combination of different factors. The internal capital adequacy assessment process (ICAAP) is very important, where we evaluate internally what are the right capital projections and what we need to do to achieve these levels.

In terms of AT1 and Tier 2, we were one of the first issuers in the European space to fill these buckets. We were the first to volunteer to fill the AT1 bucket for one reason, namely that we thought this would also have a positive effect for fixed income investors. And back in 2013 when we pioneered the AT1 market, we took a long term view.

It is impossible to measure the exact impact of our strategy, but if you look at the willingness of the investor base to invest in BBVA risk, I think it shows the value of the capital structure, it has to some extent been rewarded.