UK banks lining up to re-open AT1 market

By Will Caiger-Smith

NEW YORK, July 29 (IFR) - Several UK banks could reopen the Additional Tier 1 capital market in the weeks ahead, as yield-starved investors find more to like in the risky asset class.

AT1 issuance from European banks is down more than 50% year-to-date compared to 2015, and HSBC is the only UK bank to have sold a deal in what has been a horrid year for the asset class, pricing a US$2bn perpetual non-call five note at 6.875% in May.

But bankers say names including Standard Chartered (HKSE: 2888.HK - news) , Royal Bank of Scotland and HSBC may have a chance in August to get new deals over the line and shore up their capital buffers.

"There are a number of UK banks that have wanted to issue AT1 this year and have not been able to," one debt capital markets banker focused on UK lenders told IFR.

"They have not much more than a week between [the end of earnings] blackout and people going on holiday," the banker said.

"There is a window - and it has to be quite well timed."

HSBC and Standard Chartered report earnings on Wednesday, RBS (LSE: RBS.L - news) on Friday.

The lenders are likely to benefit from strong demand in recent weeks for higher yielding assets among US institutional investors and Asian private banking clients.

"There has been a resurgence of demand for yield products because of what central banks are doing," one syndicate banker said. "More investors globally are comfortable going down the capital structure."

Supply in the sector has been scant since February, when AT1 sold off sharply on worries that Deutsche Bank (LSE: 0H7D.L - news) might have to suspend payments on its AT1 debt.

US dollar-denominated UK bank AT1 paper traded out to an average yield of 10.93% at the height of the sell-off, according to data from MarketAxess.

There was also another burst of volatility in the sector in the run-up to the UK referendum on whether or not to remain in the European Union.

IMPROVED CONDITIONS

Yet AT1 prices have rallied overall - and market participants say issuance conditions for the asset class are now at their best since before February's sell-off.

While dollar-denominated UK bank AT1 yields were at 7.83% as of Wednesday, according to MarketAxess - more than 1.3% higher than at the start of the year - buyers are clearly more positive about the asset class and on the outlook for UK banks.

Standard Chartered's outstanding US$2bn 6.50% perpetual that is callable in 2020, for example, is trading at a yield-to-call of 8%, compared with 11% in the aftermath of the Brexit vote and north of 14% in mid-February.

RBS has a US$2bn 7.50% note, also callable in 2020, trading at 8.39%, down from 11.5% post the referendum, while its US$1.15bn 8% bonds callable in 2025 are at 8.16%, about 160bp lower than where they were on June 27.

Several recent deeply subordinated capital deals targeted towards Asian private bank investors have shown buyers are receptive to riskier instruments.

Zurich Insurance (LSE: 0QP2.L - news) , Prudential (HKSE: 2378.HK - news) and Da-ichi Mutual Life have all sold capital paper in recent weeks, predominantly to such investors.

If the UK banks do issue, they are likely to target that demand through a Reg S/144 A issue. "The Asian Reg S market has sprung back to life," said a bank capital structurer.

"It (Other OTC: ITGL - news) usually happens when the coupon is attractive compared to other opportunities, or when private banks provide new leverage to investors to buy the paper."

To meet regulatory requirements, UK banks must hold at least 2% of their risk-weighted assets in AT1 capital, which sits above common equity in the capital structure.

They are allowed to fill that buffer with cash and common equity, but AT1 securities are generally cheaper to issue.

They are designed to absorb losses, with triggers for coupon deferral and permanent writedown or conversion to equity when a bank's capital ratios become depleted.

HSBC said in its Q1 earnings call in May that it had US$10bn-$30bn of new debt and capital issuance to do to meet its capital requirements by the 2019 deadline, but did not specify how much of that would be in AT1 format.

RBS has said it has an AT1 requirement of £4bn-£5bn. It made headway into that through those two dollar notes that raised an equivalent of £2bn. It has a target of £2bn of AT1 in 2016.

The issuance of AT1 securities is likely to become a more important way of meeting those capital requirements as the UK's decision to leave the EU starts to bite into the economy, said S&P analysts in a recent report.

"Economic uncertainty following the 'leave' result  could slow banks' internal capital generation, making deleveraging and hybrid capital issuance the main drivers of future improvements in the UK banks' capital positions," they wrote.

Lloyds Banking Group (Other OTC: LLOBF - news) has already emerged as an early victim of the uncertainty around Brexit. It cut its forecast for a two percentage point capital accumulation in 2016 to 1.6 points, due to the exchange rate impact on assets. (Reporting by Will Caiger-Smith; Additional reporting by Alice Gledhill and Tom Porter; Editing by Marc Carnegie, Shankar Ramakrishnan and Sudip Roy)