March 7, 2014 / 4:33 PM / 4 years ago

Coupons plummet as CoCo demand reaches fever pitch

* Coupons drop to all-time low as market hots up

* Pricing power swings in favour of issuers

* “Mind boggling” demand unlikely to last

By Helene Durand

LONDON, March 7 (IFR) - European banks are finding unexpectedly strong demand for Additional Tier 1 bonds that many investors a year ago said they would not buy, allowing them to shore up their capital base at extremely low costs.

Nationwide Building Society, Danske Bank and Banco Santander received the equivalent of 41bn of demand for their inaugural Additional Tier 1 (AT1) issues this week, a phenomenal result considering they are so risky.

This is clearly positive for European banks, which Citigroup analysts say will need to raise 600bn of capital instruments that meet new regulatory requirements in the coming years.

“This week was a real test for the market in terms of what it could take,” said Simon McGeary, head of new products group at Citigroup. “Yet, despite the risk of indigestion, investors took it all in their stride and the tight primary deals have been pricing the secondary market tighter.”

Evidence of the market mania abounds. Some said the intensity was even greater than that seen at the height of the bull market in 2006-2007.

Another FIG DCM banker said that the 13bn of demand from close to 700 accounts on Danske Bank’ 750m trade was the largest book he had even seen for a Nordic financial issue.

There were rumours that one investor, after not being allocated on the Santander deal, put in an order of more than 500m for Danske’s trade.

“This is not necessarily a normal market however and while the current conditions may persist for a while, it may not always be like this,” said Citigroup’s McGeary.

But so far, investors are still comfortable with the asset class despite the value in the sector quickly eroding.

Danske’s AT1 came at 5.75%, the lowest coupon for the structure yet.

“According to our model, which looks at volatility, stock price, implied default probability, these bonds are priced fairly,” said Michael Hunseler, head of credit portfolio management at Assenagon. “They are no longer a bargain but they’re fair.”

But another example of the primary frenzy is Santander’s deal. That priced at 6.25%, 25bp inside where BBVA was trading in the secondary market, and 275bp inside where BBVA sold the first AT1 from a European bank last year. The two banks trade flat to each other in other markets, including CDS.

Fast money chasing yield is helping new issues perform, and providing further impetus to push spreads tighter. The question many ask, though, is for how long these conditions can be sustained.


Andrew Fraser, investment director, fixed income at Standard Life Investments, said the market would only find out whether things were overheating once demand stopped outstripping supply.

There is plenty of evidence that the developments in the Additional Tier 1 market are a reflection of what is happening in the broader credit market.

The iTraxx Crossover has tightened from 849bp in September 2011 to 225bp on Friday, while the Main has gone from 205bp in November 2011 to just below 71bp.

“The rest of the credit market has moved tighter which is dragging new investors into the asset class, including high-yield or traditional investment-grade investors who are looking for off benchmark investments,” Standard Life’s Fraser said.

David Bourne, FIG syndicate at Deutsche Bank, agreed that the sector was rapidly transitioning from a high-yield to an investment-grade product.

Fraser added that the way deals were allocated, with investors getting scaled back, provided ongoing support for the next deal.

“We will have to see what happens when an issuer defers coupon payment and I am not sure the market has fully understood this.”

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