UBS’s non-economic decision delighted AT1 market

UBS announced on December 5 that it will use the additional $2 billion tier 1 deal that it first issued in January 2018, with a 5% coupon on the first call date at the end of January 2023. The news to the applause that resounded at the bank debt capital markets tables was louder than any World Cup goal.

“This issue was the elephant in the room for European AT1s,” says one banker. “It wouldn’t be a problem if UBS didn’t call. And when he did that, it was a huge relief.”

There are rising rates changed the economy your AT1s. Banks used to publish 5% coupons now pay anywhere between 8% and 9%.

To ensure capital recognition from rating agencies and regulators, AT1 agreements must be permanent, at least in nominal terms. But normal practice has been to call on the first possible date. What encourages banks to do so – and compensation to investors if they don’t – is that coupons are set higher after the first call date.

However, this incentive is no longer valid and the UBS agreement was seen as the key test.

Recalibrated to 243 base points spread across medium swaps. This would have resulted in the bank paying about 6,375% instead of the 5% cost in the first five years had it chosen to extend the life of the instrument.

A reset spread that seemed punishing when the deal was made now looks like a giveaway. UBS has a hard time selling a new AT1 deal with close to 6.375% coupon today.

Credit Suisse is a very different beast, with ongoing operating losses and restructuring expenses that it should have increased recently. expensive new capital at a sharp discount to the already low stock price.

In June 2022, the bank famously paid 9.75% to refinance an AT1 by the first call date at the end of July. His troubles since he saw credit default swap margins disperse periodically and these new AT1s were trading below par, yielding 20% ​​returns at one point.

In October, the bank mentioned more AT1s as well as priority non-preferred holdco debt before the end of 2022. But that won’t happen now. Announced when completed of the rights issue on December 8, which he finished issuing for the year.

Regulators have mixed feelings about AT1s. If the standard practice is to call them out when clearly uneconomical, can they really be classified as permanent?

UBS is no match for its big Swiss competitor these days. He wouldn’t have had to pay 9.75% to give a new uncalled five AT1. But he may have to pay anything in the 7.75% to 8.5% range, according to FIG bankers, perhaps 200bp more than recalibrated.

“This call is clearly uneconomic,” says a FIG DCM banker.

That’s why the process was followed so closely. Everyone in the AT1 market has been talking about growing fears of extensions since the UBS deal started trading well below face value – reaching 86% at one point in October 2022.

The repurchase decision was a pleasant surprise, although the old deal began to falter as it was traded back in the mid-’90s. UBS hasn’t said how it will pay bondholders, raising the possibility of consuming high-end common equity tier 1 capital that is 410 bp above regulatory minimums, giving it about $13.9 billion to play.

This would be a very expensive capital to use, but it would accentuate its power. UBS may be considering an investment in the weighted average cost of capital across its entire debt and equity pile.

when he announced intention to saveCiting the complexity of the decision, UBS said, “This reflects UBS’ long-standing policy of calling, which is to carefully consider all relevant factors, including the market environment, economic costs, business growth and financing plans, and the current situation.” and the future regulatory value of the capital instrument”.

there are regulators mixed feelings About the AT1s. If the standard practice is to call them out when clearly uneconomical, can they really be classified as permanent? Of course, this sounds more like an argument to capture the utility of accounting revenues as capital while pocketing tax savings from paying debt coupons rather than dividends.

Everything just a little too cute for comfort?

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Dillon Lancaster, TwentyFour Asset Management

Dillon Lancaster, TwentyFour Asset Management

Dillon Lancaster, portfolio manager at TwentyFour Asset Management, explains: “For a bank like UBS with many different units with different interests, not to mention a huge pile of debt, consisting of everything from multiple AT1 issues to top-notch unsecured bonds. The negotiation need not be short-term economics; the desire to be at the top of the banks in terms of practices and bondholder relations also plays a role.”

Puja Karia, senior analyst for European banks at CreditSights, points out: “UBS is one of the best performing European banks with strong capital ratios and a history of issuing callable bonds. We believed he would want to keep this record despite the search economy.

With their AT1s trading up nearly 1.5 percent on the day of the news, Lancaster argues that announcing its intention to redeem should cause UBS’s remaining debt pile trading to tighten further over time.

More broadly, it can also remind investors that most European banks are well-capitalized and will try to demonstrate “best practice”, which means getting deals. Karia argues that “no calls will be the exception rather than the rule.”


Puja Karia, CreditSights

Puja Karia, CreditSights

Banks definitely have an incentive to keep the AT1 market alive. Paying 8% to 9% may seem expensive compared to the 5% coupons valid only two years ago, but it’s still cheap compared to the equity costs of banks currently in the mid to high tens.

But as wider credit spreads push refinancing costs with new AT1s well above coupon resets on existing deals, the prospect of no calls will remain a cause for concern. As soon as UBS announced its bailout intent, attention turned to HSBC and Barclays’ major AT1 deals approaching their first meeting date in Spring 2023.

“Who wants to bear the stamp of being the first major issuer they shouldn’t be looking for? While admitting that “no one knows the answer,” this is what we’re all trying to assess, and the true cost of not calling,” says one FIG DCM banker.

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