Uncertainty over whether Santander, Spain’s largest bank, will redeem a bond in the coming days, is raising questions about a market banks use frequently to fund their capital requirements.
Santander is yet to inform investors whether it will “call” a €1.5bn Additional Tier 1 bond, known as a contingent convertible (CoCo), ahead of a February 12 deadline, causing confusion in a market accustomed to banks repaying investors at the first opportunity.
CoCo bonds were introduced in the wake of the 2008 financial crisis to ensure that bond investors as well as shareholders bear losses if a bank runs into difficulty before any taxpayer cash is needed.
These bonds are often called “hybrid” as they convert into equity if a bank’s capital level falls below a certain threshold.
On paper the bonds have no maturity date, but banks get an option to redeem them after a fixed period — usually six years — and until now banks have almost always “called” them as soon as possible.
Santander’s bond is eligible to be called on February 12 but the bank has not yet said what it plans to do, causing wild swings in the bond’s price.
It was last trading at a cash price of 98.87, translating to a yield of 9.72%, having dropped as low as 93.8 in January, with a yield of 45%.
A Santander spokeswoman told Reuters the bank would tell the market its decision before February 12, and that the final decision on whether it would roll-over or call the bond would be based on “economic terms.”
Santander’s decision could have wider ramifications for the CoCo market as many bonds are due to be called this year.
If there is uncertainty over when such bonds will be called this will make it more expensive for banks to issue them as investors will demand a higher premium for bearing the risk.
Globally, about $13.5bn equivalent worth of Cocos are redeemable this year, around $8.4bn of which are from European banks, according to Reuters calculations based on Refinitiv Eikon data.
“This is the first time we have really seen a bank that’s not in any kind of stress really think about not calling an AT1 bond,” said Tom Kinmonth, a fixed income strategist at ABN Amro.
“Regardless of whether they do so (call) or not now, it does raise questions about this market,” he said, pointing out that Santander has a redemption date on another CoCo coming up in May this year.
Other banks with upcoming call dates on CoCos include Lloyds £1.48bn CoCo redeemable in June, Barclays’ €1.076bn CoCo redeemable in September and CIBC’s C$1bn redeemable in October, according to Refinitiv Eikon data.
Funding costs are rising rise across the banking sector, partly as a result of central bank actions to wind down stimulus programmes.
As a result, it could become more tempting for banks not to call their bonds.
“As credit spreads move wider, the economic justification to refinance changes,” said one banker who has sold Cocos on behalf of Santander in the past.
For example, Santander’s €1.5bn CoCo will reset at a spread of 541 basis points over five-year mid-swaps.
The cost of issuing a new bond may be higher.
The bank’s outstanding CoCos callable in September 2023 and carrying a coupon of 5.25% were trading on Friday at 688 basis points over mid-swaps, according to Tradeweb data.
Santander has recently issued a new dollar-denominated CoCo, raising $1.2bn, sparking speculation the proceeds would be used to call the €1.5bn bond coming due.
A banker who arranges debt sales for European banks said the uncertainty created by Santander meant investors would have to reassess how to estimate fair value on capital issuance from all banks.
“Even if they (Santander) end up calling the bond, investors will now have to take into account the possibility of this debt existing in perpetuity,” this banker said.
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