European banks are currently taking a long-term approach to their riskiest debts, engaging in a strategy involving Additional Tier 1 bonds. Notable players, like Banco Santander and NatWest Group, are issuing record amounts of these bonds with call dates extended to 10 years, aiming to secure lower borrowing costs for a decade.
The methodology here is clear. Banks choose to issue perpetual hybrid bonds during a time when investor interest is high. By extending the first call option to 10 years, they can enjoy a longer, more predictable capital cost period.
Recent developments in the AT1 bond market illustrate this trend. NatWest Group successfully issued a $1 billion reset perpetual subordinated contingent convertible AT1 bond featuring a 10-year call option and an attractive coupon rate of 8.125%. Conversely, Banco Santander has demonstrated even greater activity. The Spanish bank executed a transaction worth 1.5 billion euros, which astonishingly attracted over 10 billion euros in orders, showcasing a significant oversubscription rate of approximately 6.7 times.
Additionally, Santander has proposed a tender offer to buy back up to $850 million of an existing AT1 tranche. This move will allow them to replace older, possibly more expensive debt with new bonds issued under better terms, thereby optimizing their capital structure.
AT1 bonds are positioned at the lower end of a bank's capital hierarchy. These perpetual instruments do not have a fixed maturity date, but they do come with scheduled call options allowing the issuer to redeem them at specified intervals. If a bank's capital ratio dips below a set level, these bonds can face write-downs or conversion to equity, which accounts for their higher yields compared to senior debt options.
Why are banks opting for call dates as long as 10 years? Historically, the first call option tends to approach a success rate of 95%. Yet, a past decision by Santander not to exercise an AT1 bond call in 2019 left investors dissatisfied, briefly shaking market confidence. This has led banks to prefer extending call options to effectively eliminate refinancing risks in the near term and to lock in current spread levels for a longer duration.
What does this mean for investors? Bonds with a 10-year call not only offer enticing coupon rates, like NatWest's 8.125%, but they also come with the uncertainty of when—or if—the issuer will redeem them. Santander's ability to attract substantial orders for their offerings highlights institutional appetite for the premium yields associated with AT1 bonds, even with longer timelines.
In summary, Santander's tender offer for older debt combined with new bond offerings exemplifies a key strategy: eliminate outdated capital, introduce fresh issuance, and extend applicable timelines for refinancing. Given the risks associated with possible non-call events, which can lead to significant market movements, the longer call dates provide banks and investors alike with a broader landscape to manage economic fluctuations and a more appealing yield over a full decade compared to the traditional five-year frame.