Analysis: Banks break taboo for high-risk bonds

Aareal Bank AG

02/06/2023 07:00

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      Banks typically repaid AT1 bonds after five years
    

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      Credit Suisse wiped out billions, shocked investors
    

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      Some small banks no longer repaying
    

  
    By CarloGiovanni Boffa and Chiara  Elisei
       June 2 (Reuters) - Investors who earned easy money with
high-risk bonds invented after the financial crisis are being
forced to accept that the rules have changed: they may not get
paid.
    Banks typically sold these perpetual bonds - known as AT1
bonds - with five years before an option to repay was triggered.
In the past, investors got their money back, and banks replaced
the bonds with new ones, but some are changing tack. 
    The trend highlights the vulnerability of global finance as
it grapples with rocketing borrowing costs and the impact of war
in Ukraine.
    Earlier this year, Credit Suisse's near collapse prompted a
Swiss government-backed rescue that wiped out billions of
dollars of AT1 bonds, stunning investors and pushing up the cost
for other banks wanting to sell their own.
    Now some smaller banks are no longer repaying the bonds - in
an unwelcome development for investors - opting instead to keep
them open-ended beyond five years and paying interest on them
instead.
    Austria's Raiffeisen Bank International (RBI)  RBIV.VI  is
set to skip again an option to repay its 650 million euro ($716
million) AT1 bond in the middle of June. 
    "RBI is committed to calling and refinancing at the earliest
possible date, provide the economics make sense," an RBI
spokesperson told Reuters. 
    That follows two German banks, Deutsche Pfandbriefbank and
Aareal Bank, which also swerved milestone dates to repay 300
million euro bonds apiece earlier this year, electing instead to
keep them open. 
    The banks' actions show how the wipeout of billions of
dollars of Credit Suisse AT1 bonds still reverberates around
this market, which is estimated at roughly $275 billion.
    Investors, caught off guard, are now more wary of investing
in such bonds from mid-sized bank issuers.
    Yields on the bonds have surged to more than 10% from around
8% before the Credit Suisse's rescue as investors seek a higher
premium for the risk.
    "The AT1 market is splitting," said Alessandro Cameroni, a
portfolio manager at asset manager Lemanik.  
    "Wary of the stigma attached to not calling (repaying), big
banks will act accordingly. But for smaller issuers, that would
also like to reimburse investors ... it is now increasingly
difficult."
    
    COSTLY SPLIT
    Peter Harvey, a fund manager at Schroders, said the stress
had split the market between big strong banks and smaller
institutions.
    "With smaller, weaker banks I think you'll see more
extensions, which is obviously going to annoy people," he said,
referring to investors. 
    Investors in RBI's bond no longer expect to be repaid in the
middle of June because the bank missed a deadline two weeks ago
to publicly announce that it would repay, two investors in the
bond said.
    RBI, which has come under U.S. scrutiny over its large
business in Russia, said the higher cost of issuing a new bond
played a role in its decision. 
        
    SHOCK ABSORBER
    The AT1 bonds were designed to help banks absorb losses, and
they count towards their capital buffers. But investor appetite
for the bonds is waning. 
    AT1 bond prices sank to three-year lows during the recent
banking turmoil, according to Invesco ETF, which tracks the
market.
    The prices in the multi-billion-dollar AT1 market show that
investors only expect one tenth of bonds to be repaid as usual,
according to investment manager Federated Hermes.
    Some big banks, including Italy's UniCredit  CRDI.MI  and
Britain's Lloyds  LLOY.L , have repaid their bonds. 
    But more repayment milestones beckon. In the next 12 months,
Societe Generale  SOGN.PA  faces calls on $3 billion of debt,
UBS  UBSG.S  on $2.5 billion and Santander  SAN.MC  on $2.3
billion, based on the banks' statements.
    The situation poses a conundrum for banks which need to
borrow or refinance.
    Morgan Stanley analysts reckon that European banks need to
issue more than 400 billion euros of AT1 debt over the next
three years. 
    The current high cost will deter some.
    "The alternative," said Karsten Junius, chief economist at
J. Safra Sarasin, "would be increasing their equity and that
would be even more costly."
    

($1 = 0.9084 euros)

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EXPLAINER-Why markets are in uproar over a risky bank bond known
as AT1     urn:newsml:reuters.com:*:nL8N35S37F
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 (Reporting by Chiara Elisei and Carlo Giovanni Boffa, editing
by Jane Merriman)
 ((carlogiovanni.boffa@thomsonreuters.com; +48 58 746 90 05;))