AT1s take off after NFP shock, but credit markets quickly come back down to earth

The outlook for credit markets is finely balanced after a week in which exuberance gave way to anxiety — but not before ABN Amro, Commerzbank and Nationwide smartly walked away with Additional Tier 1 transactions that tapped into the flood of central bank-pumped liquidity. Neil Day reports, with insights from Crédit Agricole CIB’s financial institutions team.

ABN Amro and Commerzbank took advantage of surging credit markets to generate multi-billion euro order books for benchmark AT1 on Monday, but the latest bout of exuberance proved short-lived as optimism sparked by astounding US employment numbers gave way to concerns over recovery prospects and markets fell sharply into the end of the week.

Having already recovered dramatically from their March wides, credit markets engaged in their latest surge after nonfarm payrolls (NFP) on Friday blew away forecasts by showing the US economy to have put on 2.5m jobs in May, implying a fall in unemployment to 13.3% rather than the increase towards 20% that had been expected — even if the surprise number was met with scepticism in some quarters.

The US news came just a day after the European Central Bank’s latest stimulus measures had surprised to the upside, with an increase to its Pandemic Emergency Purchase Programme (PEPP) coming in above expectations, at €600bn, taking the overall amount to €1.35tr, plus an extension until at least the end of June 2021 and redemptions reinvested until at least the end of 2022.

Additional Tier 1 (AT1) issues from ABN Amro and Commerzbank were among a slew of deals from financial institutions that hit the market on Monday and Tuesday, as issuers sought to take advantage of spreads approaching pre-crisis levels.

However, while the €2.25bn of AT1 issuance on Monday attracted some €18bn of orders in aggregate and the Dutch and German banks were able to tighten pricing as much as 1% to re-offer levels at or through fair value, demand subsided on Tuesday and new issue premiums rose, as the market turned sharply. The downward move gained momentum on Wednesday as Federal Reserve chair Jerome Powell gave a downbeat assessment of recovery prospects and concerns over the number of coronavirus cases in the US rose.

“At least the week has demonstrated that in primary, deals can go extremely well, even if in the second half of the week things became more difficult,” said Vincent Hoarau, head of FIG syndicate at Crédit Agricole. “Indeed, after the market rallied in the wake of the shocking NFP, the initial correction may have been healthy — in the eyes of many, we had come too far, too fast.

“But it is now clear that the overall backdrop is becoming more fragile, with the return of volatility. The reality is that many headlines are bad — GDP and unemployment forecasts released this week, in particular.”

The extent to which the latest leg of the recovery had swept all before it was borne out by the performance of higher beta peripherals, according to CACIB AT1 trader Nigel Brady, who noted that UniCredit 3.875% perpetual non-call 2027 paper, for example, had tightened some 20 points in the previous two weeks — before giving up around five points.

“That shows the extremeness of the moves that we’ve seen in many cases,” he added.

While the upswing and subsequent downturn may have been based on low volumes by historical standards, recent performance has nevertheless been based on real money buying, said Brady.

“Across credit in general and particularly in the sub space, real money — many of whom were previously underinvested — has picked up the pace,” he said. “It’s quite clear that the stimulus money has fed through and the rally hasn’t been led by the Asian private bank side, as is often the case, but by US real money in the dollar space and European real money buying euro deals.”

Commerzbank’s decision to come in euros rather than return to dollars, where it debuted last year, was a testament to this, he added.

Last Friday’s nonfarm payrolls after the ECB’s PEPP announcement were then the icing on the cake, according to Neel Shah, financial credit analyst at CACIB.

“Clients don’t want to be behind the curve in terms of any rally,” he said. “We saw this in Friday’s move and the strength of issuance in the subordinated space on Monday.”

With the correction earlier in the week having evolved into more of a rout yesterday (Thursday), the question now is whether investors view the latest move as a threat or an opportunity, according to Hoarau.

“The level of cash is extremely high while many institutional investors did not benefit from the rally, particularly in equities,” he said. “Are we moving towards a relapse where they get a second chance? If so, they are likely to again play the convergence and compression game — non-core tightening versus core, Tier 1 versus Tier 2, SNP versus senior preferred — given the relatively limited risk implied by bank subordinated instruments and the accommodating approach taken by the regulators.

“Still, the magnitude of the credit spread widening and equity losses on Thursday was impressive.”

While acknowledging that calling the market’s next move is tough, Hoarau argues that technical supports remain intact, with global central bank stimulus measures supporting economies and liquidity, and supply-demand dynamics helping.

“Behind the scenes, the EU news around the recovery fund continues to support valuations, while Powell’s comments mean the ‘lower for longer’ rates mantra is now valid for the US,” he said. “That should help even if he poured cold water on the prospect of a V-shape recovery — the global economy is in recession and entering into a new business era, and central banks and worldwide governments have never been so accommodating.

“However, there is room for disappointment at current valuation levels as the market was priced to perfection — at the beginning of the week, at least.”

AT1 moves vindicated

Indeed, ABN Amro and Commerzbank could hardly have hoped for better outcomes when they approached the market on Monday.

“The deals were extremely well absorbed and multiple times oversubscribed,” said Hoarau, “with issuers extracting zero or negative new issue concessions. The tightening of the AT1s by a full percentage point illustrated some of the signs of exuberance.”

ABN Amro opened books with initial price thoughts (IPTs) of 5.25% to 5.5% for its perpetual non-call 5.25 euro benchmark AT1, rated BBB- by Fitch. After an update putting orders above €5bn, guidance was set at 4.75% for a €1bn size. Books peaked above €10bn, with over €8bn of orders good at the final coupon of 4.375%.

Commerzbank went out with IPTs of the 7% area for its perpetual non-call six euro benchmark AT1, rated Ba2/BB- by Moody’s and S&P. Guidance was later set at the 6.375% area on the back of more than €7bn of orders, and a €1.25bn deal was ultimately priced at 6.125% on the back of books above €9.5bn, pre-reconciliation.

Commerzbank’s deal is the first off a €3bn AT1 issuance programme it established last month

“The first transaction under our new issuance programme has been met with great interest,” said Commerzbank CFO Bettina Orlopp. “As a result, we were able to issue the bond with very good conditions.

“The further improved capital structure gives us additional leeway,” she added.

The bank said the issuance strengthens and optimises its capital structure, and makes use of the recent regulatory changes whereby AT1 can now be used to a greater extent to meet capital requirements (SREP). Combined with Commerzbank’s recent €750m Tier 2 issue, the AT1 reduces Commerzbank’s CET1 requirement (MDA threshold) to 10.07% pro forma at the end of March 2020, it said.

Although the Dutch and German trades quickly fell below par on Tuesday, bankers said this was simply the result of them being caught up in the broad correction and the frothiness of order books in the toppy market, rather than reflective of their execution.

“The ABN Amro deal was priced at fair value and Commerzbank’s slightly through value,” said CACIB’s Shah, “but even with a book eight times covered, there was little interest from investors to add in secondary, as the bonds fell from par to a cash price of 99.

“This just shows how quickly market sentiment changes and the quality of the order books.”

The market nevertheless remained open through the first half of the week, and after La Banque Postale and Société Générale had sold senior non-preferred bonds on Monday, further financial institutions supply ensued on Tuesday, ranging from senior preferred — a €1.25bn six year non-call five UniCredit senior preferred issue at 160bp over mid-swaps and a €500m seven non-call six green bond from KBC (with CACIB as joint bookrunner) at 72bp — to an RBI €500m 12 non-call seven Tier 2 and a €750m 30.25 year non-call 10.25 subordinated trade from Zurich Insurance (see article here for more).

By Wednesday, conditions had deteriorated to the extent that some issuers who had been eyeing the market decided to hold off.

However, Nationwide Building Society proceeded with a £750m (€836m) perpetual non-call 7.5 AT1 and was able to tighten pricing from IPTs of 6.25% to final pricing of 5.75% on the back of more than £4.5bn of demand, pre-reconciliation. Although the outcome was deemed wide of where the issuer might have priced at the start of the week, Nationwide said that it was worth going ahead given the risk of conditions deteriorating in the second half of the year, with Brexit an added concern for UK issuers.

“If you look at how markets have moved since ABN Amro, Commerzbank and Nationwide issued, their decision to pull the trigger has been vindicated,” said CACIB’s Hoarau. “They could have waited further in anticipation of a better funding level, but they were wise to adopt a realistic approach.

“They also enjoyed a bit of luck,” he added. “Many issuers were in the pipeline and did not grab the window.”

Should markets stabilise, financial institutions planning new issues are now expected to approach the market ahead of blackouts leading up to the second quarter reporting season from mid-July, which is viewed as the next potential risk to market sentiment in the calendar, alongside an EU summit where the bloc’s resolve to tackle the Covid-19 crisis in cooperation will be tested.

The AT1 market meanwhile enjoyed some political relief early in the week, when it became clear that proposals by some Members of the European Parliament to subject AT1 coupons to similar prohibitions to bank bonuses and equity dividends came to nothing.

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