September sets AT1 record ahead of 2025 peak, bringing par call strategies to the fore
Record AT1 supply last month reflected not only demand- but also supply-side factors, notably 2025 having the busiest calendar for calls yet, thanks to the accumulation of issuance over the past decade. As such, the activity offered critical insights into investors’ and issuers’ stances vis-à-vis the instrument, especially the par call feature. Neil Day reports, with insights from Crédit Agricole CIB.
Additional Tier 1 issuance is nearing its biggest yearly total after a bumper 16 benchmark trades from European financial institutions in the space of a month, with issuers taking advantage of buoyant conditions to pre-empt upcoming calls and supply providing insights into behaviour around par call structures.
The 15 September benchmark AT1 deals for around €12.6bn-equivalent across euros, sterling and US dollars lifted year-to-date issuance to around €36.5bn, with Commerzbank adding $750m (€672m) on Tuesday of last week (1 October). This compares with around €26bn in the whole of 2023 and is only around 10% shy of the record set in 2014 when AT1 issuance was initially ramped up.
Momentum continued through September after a lightening start in the first week of the month (see previous BIHC Briefing), the peak marked by a $800m perpetual non-call 7.5 trade from Nordea on 19 September — the day after the Federal Reserve delivered its first rate cut, and in size, cutting by 50bp rather than 25bp. The Scandinavian bank’s deal was priced with a 6.3% coupon, some 20bp through fair value and tightened from initial price thoughts of the 7.125% area on the back of $11.5bn-plus peak and $6.8bn-plus final books.
Doncho Donchev, executive director, DCM Solutions, Crédit Agricole CIB, cites four factors as driving the financial institutions’ AT1 issuance.
“Cash rich investors have been swarming new AT1 issues for the high coupons they offer in anticipation of falling rates,” he said, “with the Fed delivering the big one after the ECB and Bank of England had taken their first steps.
“Then there is the fear of the US election — not so much who wins, but what happens if it is a contested election that creates volatility and closes the market? And let’s not forget residual fears of a recession — everyone is talking about a soft landing, but what if we have a hard landing?”
Finally, notes Donchev, some €36bn of AT1 call dates are scheduled in 2025 across euros, dollars and sterling, making it the biggest ever year in this respect, as calls under various perpetual non-call five, non-call seven and non-call 10 structures coincide for the first time. Institutions such as Deutsche Bank, Intesa Sanpaolo and UBS have as many as three AT1 call dates next year.
Too far, too fast for some
Nordea’s AT1 transaction was one of eight new issues (nine tranches in total, with HSBC issuing dual-tranche) in US dollars from the beginning of September to Commerzbank’s on 1 October, totalling $11bn.
The market’s direction was evident from the Nordic perp non-call 7.5 deal’s coupon of 6.30% being more than 1% inside that of an, admittedly longer dated, perp non-call 10 from BNP Paribas just 16 days earlier, on 3 September, with AT1 yields and spreads collapsing much faster than moves in underlying US Treasuries. The attrition evident in Nordea’s book, with 40% of orders by volume dropping, suggested the market had moved too far, too fast for some accounts.
Conditions nevertheless remained ripe, with Crédit Agricole selling its first dollar AT1 since January 2022 on 24 September. The French bank approached the market on the back of consistent reverse enquiries and following a non-deal roadshow across the US and Asia, going out with IPTs of the 7.25% area for a perpetual non-call 10 trade. After the order book peaked at $9.1bn, the deal was sized at the maximum targeted $1.25bn size on the back of a comfortable final oversubscription and priced at 6.70%, with a reset margin of SOFR plus 359.6bp, more than 50bp better than achieved on recent issuance from Crédit Agricole’s peer group.
The issuer was nonetheless mindful of investor sentiment, according to Donchev.
“While it attracted some investors that many European issuers can only dream of, high quality buy-and-hold accounts including some insurance companies and pension and sovereign wealth funds,” he said, “some investors were price sensitive from the start, while some classic AT1 investors simply dropped. In this market, you have to be aware that there can be some investor reticence and not squeeze too aggressively.
“We are seeing barbell distribution, with the top 10 to 20 accounts taking the lion’s share of AT1s,” added Donchev (pictured), “then hundreds of smaller investors with small allocations, and some trading accounts. Execution is still tied to the large specialist funds — issuers can afford to lose one or two, but beyond that a deal may come apart.”
The book for a $1bn perp non-call seven issue for Lloyds Bank two days later peaked at some $5.25bn, with pricing tightened from the 7.125% area to 6.75%, while Commerzbank’s $750m perp non-call 6.5 was tightened from the 8% area to 7.5% on the back of peak $5.25bn-plus and final $4.2bn-plus books.
The German bank’s deal came amid takeover talk, with UniCredit eyeing Commerzbank, and after it had sold a €750m 7.875% perp non-call 2032 AT1 in June. Commerzbank noted that the pricing of the new dollar issue was substantially inside comparable euro funding levels.
Par calls: theory versus practice
As well as providing welcome opportunities for issuers and investors alike, the AT1 wave offered clues as to how so-called “par calls” are being viewed and used by each side of the market.
The par call feature of hybrids separates the first call date and first reset date — typically by six months for AT1s and three months for Tier 2s — with issuers able call the instrument at par at any time during the intervening period. Issuers thereby have additional flexibility on the replacement of capital instruments and it allows for a reduction in the potential cost of carry.
But as par call periods approach, the difference in returns realised by investors if the bond is valued to the first or last possible call dates diverges greatly. Investors meanwhile have to track the varied documentation of different issuers, including coupon resets and call frequency after the first call date.
After being introduced and widely used in the corporate space, the par call feature began being used in the banking and insurance sectors in 2019, so — with the earliest par call date being five years — it is only now that evidence of how bank issuers would use them in practice and how investors would position themselves has been emerging.
With investors typically valuing AT1s to the first possible call date at the start of the par call period, their interest lies in issuers exercising calls at that point.
Among smaller or infrequent issuers with lower AT1 amounts outstanding, the question of how the par call feature would be used in practice has now been answered via a few concrete cases: Ireland’s AIB and Bank of Ireland, as well as Iceland’s Arion, launched new issues alongside tenders for their outstandings well in advance of the opening of their par call periods in late 2024 and 2025.
“The feature sounded nice in theory,” said Donchev, “but in practice these banks have not used the feature so far. And not only did these banks not use it, but they gave a very clear feature to investors that they wanted to refinance their AT1 bonds in advance.
“This could have been simply a function of the very attractive market,” he added, “but I expect investor pushback was a factor, too, with these banks requiring regular access to the capital markets, even if they are not the largest.”
Among bigger players, the first issuers with par call periods approaching, in December, have also pre-empted par call periods: Nationwide Building Society issued a £750m (€890m) 7.5% perp non-call 6.75 on 9 September ahead of compatriot Lloyds’ dollar AT1. This has heightened anticipation that the two will call their outstanding issues at the first opportunity, with Lloyds’ action more eagerly awaited as it is one of the few banks not to have called an AT1, in May 2020 amid the impact of Covid.
When push comes to shove
With par calls having yet to serve their theoretical purpose — not to mention the complications of appropriately hedging AT1s incorporating the feature — some issuers have decided to dispense with them in their latest new issues.
Having previously included par calls in recent AT1 issuance, ING Groep and KBC dropped them from $1bn 7.25% perpetual non-call 10 and €750m 6.25% perp non-call seven trades on 5 and 10 September, respectively, as did Crédit Agricole and Lloyds from their new issues. Alpha Bank meanwhile reduced the par call period from six to three months as a mitigant to investor concerns. However, UBS introduced a six month par call for the first time, on a $1.5bn 6.85% perp non-call 5.5 on 5 September.
Other issuers to have previously included the feature retained it, while ABN Amro and BNP Paribas, in line with their previous AT1s, continued without par calls in their euro and dollar deals that reopened the respective markets.
“Because of a combination of hedging issues and how the par call has developed in practice, some issuers have not included them,” said Donchev, “and have used this as a marketing feature for their new issues, aware that there has been verbal pushback from some accounts. However, while investors may be happy with the lack of par calls, there has been no discernible impact on the outcome of the trades.
“Has it affected the book quality, oversubscription and the performance of deals? Absolutely not. When push comes to shove, demand is a function of where the market is, how investors see relative value, and how much money they can make.”
However, Donchev notes that investor feedback suggests they may reassess the way they view and calculate returns for AT1s with par calls should a major bank decide to make use of the par call period.
The next test case on the horizon is Intesa Sanpaolo, which has a €400m 5.875% AT1 with a first call date of 20 January 2025 and first reset date of 20 June 2025.
Another technical development in AT1 supply has been the first Yankee issuance with SOFR-based resets, rather than US Treasury-based resets. UST-based resets had been the norm for dollar AT1s with the phasing-out of Libor, but the emergence of the reliable SOFR-based swaps curve in the past couple of years has allowed issuers such as Crédit Agricole, ING and UBS to use it as the basis for resets in their new transactions.
Having a SOFR-based reset avoids basis risk versus Treasuries for issuers using swaps to switch from fixed to floating coupons, while investors have cited easier comparisons of such dollar AT1 with euro equivalents as an advantage of the development. Recently the difference between SOFR-based resets and UST equivalents has been some 60bp.