Redemption delay fears send yields on European banks' CoCo bonds spiking
By CarloGiovanni Boffa, Valentina Za and Chiara Elisei
MILAN (Reuters) - Turmoil in the banking sector has sent yields on the riskiest bonds issued by European lenders including UniCredit, Santander and BBVA spiking as investors price in the risk they may not be redeemed as soon as possible.
To beef up their regulatory capital and meet requirements over their ability to withstand possible losses, banks often sell hybrid instruments that stand between debt and equity known as contingent convertible (CoCo) bonds.
CoCo bonds convert automatically into equity or are written off if there is a capital shortfall.
Among CoCo bonds are Additional Tier 1 (AT1), which are perpetual and count towards banks' AT1 capital. Under an unwritten agreement in the market, investors expect AT1 bonds to be redeemed at the first call option date.
Distress in the banking sector following bank failures in the United States and trouble at Credit Suisse has dried up liquidity in the AT1 market, traders said, sending yields soaring on bonds with a call option in the near future.
The yield on a perpetual bond issued by UniCredit with a call option in June and a 6.625% coupon rose above 30% on Thursday and was little changed at around that level on Friday morning, Refinitiv data showed.
An AT1 bond with a 5.25% coupon issued by Santander yielded more than 17% on Friday, similar to an AT1 bond by BBVA with a 5.875% coupon. Both bonds have a call option in September.
Such yields would make it prohibitive for lenders to tap the market and are a further sign of stress in a sector that has lost 13% in stock market value since Thursday last week.
"The jump in UniCredit AT1 yield is a reflection of the risks arising that the bonds would not be called. It would be very difficult for banks to come to market now and issue AT1 debt," said Joost Beaumont, head of bank research at ABN Amro.
"The market is telling you that the turmoil might stay for some time and extension risks are higher."
Traders said the proximity of the date to call the bond amplified the effect on the yield of the cash price movement, which in turn was affected by the lack of liquidity in the market.
A senior source on a bond origination desk said the market movement did not reflect concerns about the lenders' health but simply the possibility that it may be too disadvantageous - given current market prices - for them to repay the bonds.
Lenders need supervisory clearance to repay such bonds because they effectively eat into their regulatory capital doing so.
Banco Santander in 2019 became the first European lender not to redeem this kind of hybrid debt when it opted not to call a 1.5 billion euro AT1 bond.
(Reporting by Carlo Giovanni Boffa in Gdansk; Valentina Za and Giulio Piovaccari in Milan; Chiara Elisei in London; Editing by Mark Potter)