25th January 2019

BCP AT1 high coupon and high risk | Bank Capital Insights

BCP re-opens the EUR AT1 market – valuation thoughts

Who would have imagined that the first AT1 deal of 2019 would come from a Portuguese Bank and that on the day of the ECB meeting?  BCP, Portugal’s largest private sector bank issued its debut EUR AT1 paying a coupon of 9.25% for a Perp NC5 structure and EUR 400 million in size.

To a large extent getting paid in excess of MS+900 bps on an AT1 (with a 5 year call) makes it attractive and given the size, it probably will hold up reasonably well.  The high coupon and small issue size will mean shorts will find it difficult to go after this.

High coupon for perceived high risk balance sheet

Whilst the coupon is indeed attractive and reflects the risk premium on the name, the real question to me is – what is the recovery value on a potential trigger due to capital event or due to point-of-non-viability resolution (remember BESPL)? But also, if investors have done enough work to estimate losses in a severe stress scenario and carried out a waterfall of the capital shortfall?

The bank does generate decent pre-provision income and is able to cover its loan losses in most cases, it still has a high NPE (6.3%) and a large corporate banking loan book. Customer deposits have been steadily climbing and now entirely funds the loan book but still there is a reliance on headline sensitive deposit funding.   Yes, they can borrow more from the ECB to offset any drop in deposit funding.  But will regulators impose a PONV event if it came to high deposit withdrawals and hence more ECB funding?

Low probability but high loss on trigger event

Regulatory capital ratios look fine but absolute capital levels seem low for the balance sheet risks.  Also, the bank has a large sovereign debt portfolio (almost double the bank’s equity).  As of 30 Sept 2018, the bank had an equity capital base of EUR 5.8 billion supporting total assets of EUR 71.7 billion (leverage ratio of 7.3%).

If and that is a big if, NPE were to go to back to double digits in the event of a very sharp slowdown, the drop in CET1 ratios would be significant and that point the chances of trigger event occurring go up materially.

I just wonder if investors have done the deep dive work to stress the balance sheet risks and price the trigger risks.  They might have done that and comfortable with the risks and feel adequately compensated by the high coupon.

My limited analysis (based on the information as of 30 Sept 2018) indicates that immediate coupon and trigger risks are low for now and everything depends on the extent of slowdown in Europe and the evolution of the bank’s NPEs,

In a severe downturn (and I assign a low probability) I see both absolute levels of capital and regulatory ratios come under pressure and at point this AT1 will be at play.  And any trigger event will see significant drop in recovery value.

Personally, I would have required a double digit coupon on this one (more so after all that happened with BESPL and POPSM AT1s).

But that is just me.

The above notes reflects my personal views on the valuation of this instrument and investors should do their own work and to that extent this note is pure advisory in nature.  

For information about our bespoke portfolio risk service, click here

GJ Prasad

A senior European bank research specialist with significant breadth/in-depth sector knowledge, GJ has researched bank capital instruments extensively - having covered the asset class for more than 15 years as an analyst and 7 years as a risk taker in buy-side roles. His specialisation includes carrying out detailed financial modelling work on the European banks focusing on asset quality, earnings and capital adequacy metrics. His deep-dive work focuses on single name selection and extensive risk analysis on capital securities, especially on structural features, issuer credit profile and equity/AT1 valuation.