Coventry AT1 tender/new issue promises savings

Coventry Building Society offered a template to more economically manage upcoming calls of Additional Tier 1 last month when it launched a tender offer for an AT1 ahead of its first call and less than five years since its launch, in conjunction with a new AT1 issue.

Under CRR, issuers are prohibited from reducing AT1 or Tier 2 issues before their fifth anniversary except for in certain restricted circumstances — if the instruments face regulatory disqualification or unfavourable changes to their tax treatment; or, in exceptional circumstances, if they are exchanged for capital of the same or better quality. The latter possibility had previously only been tested in Tier 2, by Standard Chartered and Bawag last year.

However, Coventry Building Society gained approval from the UK’s Prudential Regulation Authority (PRA) to on 25 March launch a tender offer for its only outstanding AT1, a £400m (EUR462m) 6.375% perpetual issue, ahead of its first call on 1 November and less than five years since its launch in June 2014. The tender was conditional upon the successful issuance of a new AT1, a £415m perpetual non-call 5.5, which was launched the following day and priced at 6.875%.

According to market participants, the PRA will have allowed the exercise by virtue of treating it as equivalent to an exchange.

The key advantage for issuers of following Coventry’s example is likely to be reducing the cost of carry incurred by prefinancing upcoming calls ahead of time. This was highlighted by Gary Kirk, partner and portfolio manager at TwentyFour Asset Management, which held a significant holding of almost 60% of the outstanding AT1 and precommitted to taking at least 25% of the new issue. He noted that issuers, particularly less frequent ones, could face the quandary of deciding between refinancing early or waiting to closer to call dates and risk facing higher levels.

“We believe that the announcement by Coventry Building Society yesterday afternoon is a novel solution to this quandary,” he said, “which we expect will be strongly welcomed by many borrowers who would be looking at the potential refinancing of their AT1 capital and are considering the punitive costs of overlapping new securities with those being refinanced.”

Coventry also said that the tender offer and new issue would provide liquidity to holders of the old AT1 bond, whose liquidity would be hit if the significant holding were to be removed.

The building Society attracted some £650m of orders to the new AT1 on 26 March, with priority to be given to investors tendering existing holdings in the tender. On 2 April Coventry announced that £385.1m of the outstanding issue was validly tendered and accepted for purchase, equivalent to a 96.275% hit rate.

Doncho Donchev, DCM solutions, Crédit Agricole CIB, said that in Coventry’s case, the issuer will not have made any material savings on replacing AT1 early and avoiding the cost of carry — even if it achieved interest savings amount to an estimated £5.377m, incorporating a 102.25 tender offer price — once the costs of the new AT1 issuance and liability management exercise are taken into account. He furthermore noted that the issuer could have chosen to not call the outstanding AT1, with the new AT1 being much more expensive, having a reset spread some 170bp higher.

Donchev nevertheless cited several motivations for the trade:

Coventry Building Society wishing to protect its reputation for being very correct with bondholders.

This in turn is motivated by further MREL needs and the concentrated GBP sterling investor base, which can under circumstances limit market access for a small issuer or elevate its costs of funding.

It enables the execution of the new AT1 deal, with the need to effectively manage credit lines for this concentrated investor base. This could have been of particular relevance to the key investor.

Brexit and issuance context: the issuer elected to go for relatively stable market conditions, which may not have been available thereafter, particularly in the event of a no-deal Brexit.

“The transaction is highly issuer-specific,” he concluded, “yet it has important takeaways for smaller banks who may be facing AT1 and MREL funding requirements.”

EU issuers will meanwhile face greater flexibility on similar issues under CRR2, noted Donchev, with the updated regulation introducing in Article 78 (4) (d) a provision allowing replacement of an existing instrument ahead of its fifth anniversary by a cheaper one.