Maturing AT1 market loses lustre

* Investors become more selective as AT1 pool grows

* Weaker names and repeat issuers could face uphill battle

* Some place issuance plans on hold

By Alice Gledhill

LONDON, Sept 18 (IFR) - Banks looking to sell the riskiest form of debt could be in for something of a wake-up call as investors, increasingly spoilt for choice, stop chasing every new deal.

ABN AMRO this week priced its first ever Additional Tier 1 issue, a 1bn 5.75% perpetual non-call five-year that attracted around 3.5bn of demand and disappointed market participants who had expected a blockbuster trade and a 1.25bn to 1.75bn size.

Demand for the issue was a far cry from the market's earlier days when order books frequently topped 10bn or more as investors jostled for allocations, and raises questions as to how future issuance will be digested.

"If you want exposure to the asset class, you don't have to chase every deal that comes along and people can afford to ignore some of the new trades," said Dierk Brandenburg, senior credit analyst at Fidelity. "There are hardly any first time issuers left while new deals don't offer a real premium anymore."

Much of this year's 30bn of AT1 supply has come from national champions such as ABN. And this has given investors scope to be somewhat more discriminating and demanding.

For banks that have multi-billion Additional Tier 1 targets, this could mean that the equilibrium swings back in favour of investors.

Intesa Sanpaolo (Amsterdam: IO6.AS - news) has said that it wants to raise 4bn by the end of 2017. Banks like HSBC and BNP Paribas (Xetra: 887771 - news) have even bigger targets. The UK bank is targeting US$6-8bn a year until 2021 while BNPP is aiming to issue 1bn to 2bn a year until 2019.

One of the reasons why the shine has come off the asset class is because pricing has come down substantially since issuance started in 2013.

"Investors are not buying these deals for the 1-2 points performance on the break and it's become more of a carry market when you can clip a coupon," said a head of FIG syndicate. "The Additional Tier 1 market has matured a lot and it's become more socially acceptable to own."

For example, a 1.5bn 5.5% perpetual June 2020 for Rabobank priced in January this year at par was quoted at a 5% yield on Friday and was bid at 101.95.

MOVING TARGETS

This is not the only hurdle. Incoming (Other OTC: ICNN - news) rules around Minimum Requirement for Own Funds and Eligible Liabilities (MREL) and Total Loss Absorbing Capacity (TLAC), in particular, pose hurdles to forecasting capital needs and banks expect their capital projections to change at year-end, Morgan Stanley (Xetra: 885836 - news) analysts wrote in a note this week.

The evolving regulatory backdrop makes life more difficult, not only for issuers but also for investors, and can weigh on appetite.

"The pressure on bank capital and RWAs remains constant," said Gildas Surry, a portfolio manager at Axiom Alternative Investments.

For example, market participants still do not know whether Maximum Distribution Amount (MDA) buffers, which can turn off AT1 coupon payments, will be reduced by bank-specific capital requirements known as "Pillar 2".

Surry also pointed to the recent flow of negative updates around other factors impacting AT1 capital such as risk-weight floors, the supervisory review and evaluation process ("SREP") and domestic buffers.

"This results in more differentiation across names and investors have to be more selective."

SURVIVAL OF THE FITTEST

But it is not just repeat well-known issuers that are likely to see the pendulum swing further away from them.

Weaker banks and those with aggressive yield targets may find it increasingly difficult to drum up demand after investors have gorged on almost 90bn of supply from European banks since 2013.

"I dare not think what would have happened if it had been a bank with a weak profile trying to do AT1 in that market," said a head of FIG DCM. "ABN managed to get a solid trade away, helped by its name. They didn't pay up to get it done, but clearly, this was no blockbuster."

ABN priced the BB/BB+ issue at 5.75% in a tricky market that was nervously waiting on whether the US Federal Reserve would raise rates or not.

Even (Taiwan OTC: 6436.TWO - news) when conditions were more stable earlier this year, weaker credits such as Banco Popular Espanol and Permanent TSB (EUREX: 27526365.EX - news) opted to place AT1 away from the public market, paying respective coupons of 8.250% and 8.625%.

Some do question how banks will fare if the market backdrop remains soggy and the hunt for yield that was so prevalent dies down.

Spanish lenders Caixabank (Other OTC: CAIXY - news) , Bankia (Amsterdam: QU8.AS - news) and Sabadell are all seeking to issue AT1 when market conditions allow, according to one investor, but Greek-led volatility has caused difficulties.

"They've got a threshold and it's not there yet," he said.

Germany's NordLB mandated banks for an AT1 bond in April this year but backed away due to the high coupon required to get a deal away. Bankers say it is still intending to bring the trade but may need to be more flexible on price.

(Reporting by Alice Gledhill, editing by Helene Durand and Sudip Roy)