* UniCredit AT1 coupons dependent on tightly timed capital raise
* 2016 sell-off unlikely to repeat itself
By Helene Durand
LONDON, Jan 12 (IFR) - Concerns around banks’ ability to pay coupons on their Additional Tier 1 debt were reignited on Thursday, when UniCredit said it might not have capacity to do so if its capital raising plan is not completed on time.
The yield on the Italian lender’s 1bn 6.75% perpetual non-call September 2021 AT1, the riskiest type of debt a bank can sell, rose to 8.644% from 8.465% on Thursday as the market tried to get to grips with the possibility of seeing a coupon skipped.
The Additional Tier 1 market went through a savage sell-off in the first quarter of 2016, as worries around Deutsche Bank’s ability to pay its AT1 coupons stoked the flames of a broader rout in the asset class.
While appetite for risky assets has been strong in 2017, the UniCredit news comes as a reminder of how the market can get caught off guard by some of the more technical aspects of the asset class.
“If investors were not aware of the risks, then this is another reminder that if you have insufficient capital, then AT1 coupon risk does exist,” said a hybrid structuring banker.
“Should people be caught off guard though and be surprised? Probably not if you follow this closely, and it’s lazy investing if you change your mind based on this press release.”
While it was anticipated in December that the decision to frontload impairments would have an impact on UniCredit’s Common Equity Tier 1, the bank had not made it as clear as today that it could have a direct impact on AT1 coupon payment capabilities.
UniCredit unveiled an ambitious capital raising plan at the end of 2016, including a 13bn rights issue aimed at plugging a 12.2bn hole primarily created by bad loan provisions.
That will help cover a 8.1bn provision to cover Fino, a vehicle intended to speed up the rundown of UniCredit’s non-core assets, and to increase its provisions on non-core loans.
As the bank is taking such a large hit on capital, it will have an impact on its capital ratio and in turn its so-called Maximum Distributable Items (MDAs).
The MDA is effectively a firm’s distributable profit. If it is too low, banks can be barred from paying their AT1 coupons.
According to CreditSights, UniCredit’s MDA cushion was 6.1bn as of the third quarter of 2016, which the charges taken by the bank will wipe out.
In its statement, the bank said that if its capital raising plan was not successful, it could “have temporarily negative impacts on the capacity of the UniCredit Group ... to pay out coupons on its Additional Tier 1 instruments”.
The bank is planning to launch the key plank of its capital raise after its full-year results due on February 9, leaving it with a month to complete its rights issue before the coupon on its non-call 2021 AT1 is due to be paid on March 10.
“While we expect the transaction to be completed successfully and on time for the coupon payment, there is some degree of execution risk which does not appear to be priced in at present, in our view,” BNP Paribas analysts wrote in a note on Thursday.
One investor said that the level at which the bonds were trading indicated that one coupon could be lost.
“Coupon risk is an essential part of the construction of AT1 instruments, and while the most recent regulatory developments have pushed for priority of payments for AT1 and a lowering of the hurdle rate to pay them, there is still a tail risk,” he said.
“UniCredit is dependent on completing its right issue and has to raise a massive amount, in absolute terms and in terms of its market capitalisation.”
THIS TIME, IT‘S DIFFERENT
But while the announcement led to a sell-off in some of UniCredit’s AT1 instruments, market participants believe that concerns are unlikely to spread to the rest of the market.
“We have known for a long time that there are uncertainties linked to the coupon payment calendar, and it’s something that issuers and experts in the asset class know well,” said another portfolio manager.
“It is a reminder that some of the technical aspect of the products can catch the generalists out but, fundamentally, the spirit of the instruments and the way they are issued suggest that coupons should get paid.”
Other AT1 bonds barely moved on Thursday. Intesa Sanpaolo’s 1.25bn 7.75% perpetual non-call 10-year was bid at 7.781%, roughly in line with Wednesday’s level, for example.
That stability reflects the steps taken by regulators during 2016 to make the asset class more investor-friendly, giving banks more breathing room by tweaking Pillar 2 requirements and prioritising AT1 coupon payments over bonuses and dividends.
“It looks like the situation from one year ago, but I‘m not worried,” added a hybrid specialist. “It’s very specific and very technical.” (Reporting by Helene Durand, additional reporting by Alice Gledhill, editing by Sudip Roy, Philip Wright)