Context is key: Banco Santander’s decision to skip the first call on a EUR1.5bn AT1 security should probably be seen in the context of now-entrenched changes to the regulatory capital framework under Basel III. For many banks, these changes have all but removed the economic incentive to exercise such options. The decision should also be viewed vis-à-vis the much more chequered track record of banks exercising calls since Deutsche Bank’s infamous decision to leave a EUR1bn Lower Tier 2 instrument with a coupon step-up outstanding, which was announced in December 2008.
Three possible implications: We think there are at least three possible takeaways from this week’s events for the universe of CEEMEA perpetual securities. First, the market may place more emphasis on bond valuations to perpetuity rather than to the first call dates. Although these securities may have a series of call dates (rather than once only calls), assessing the attractiveness of yields to perpetuity may play a bigger part in deciding whether or not to invest. Further, the market may increasingly focus on terms and conditions as stated in bond documentation, regardless of what issuers choose to signal. Finally, placing new capital instruments may no longer be seen as indicative of banks’ intentions to exercise near-term call options.
Valuations in focus – YTC vs. YTP: Based on indicative Bloomberg levels, the yield to perpetuity appears to exceed the yield to the first (or next) call for most perpetual securities issued by financial institutions in CEEMEA. In addition, most bonds are not quoted significantly below par. In isolation, these factors suggest that the market currently expects many of these securities to be redeemed at the first call dates. We think securities should be assessed individually and, even in emerging markets, redemption at the first call date may not always be a given.
2022 will be a crucial year for calls: CEEMEA financial institutions now have more than 30 perpetual securities outstanding. Only four of these securities have first call dates in 2019, and all four were issued by lenders in the Middle East, where local market dynamics could play an important role in banks’ call decisions. Over US$5bn of these CEEMEA perps are callable for the first time in 2022, making that year the most important for this subsector of the market. The VTB 9.5% Perp accounts for US$2.25bn of this. We acknowledge that another quasi-sovereign lender, Gazprombank, decided to skip the first call on its perpetual instrument in April last year. However, we think it is difficult to extrapolate what happened at Gazprombank last year to what VTB may decide in 2022.
Tier 2 calls are also important: We think Tier 2 calls will continue to be assessed on a case-by-case basis. In Russia, state-owned banks such as Russian Agricultural Bank and Sberbank have called their Tier 2 instruments at the first call dates. In Nigeria, FBN has called two subordinated instruments in the past and has a third due to be called later this year. We think the bank may consider some form of liability management, such as an exchange offer, to maintain its presence in the eurobond market. In Turkey, what Vakifbank decides to do with its ‘new style’ Tier 2 security – which is callable next year – will be closely watched. The VAKBN 6.875% bond is the first of such securities coming up to be called.