13th February 2019

To Fall or Not to Fall on the Non Call | Bank Capital Insights

Head Scratcher or Mis-priced Hope?

Banco Santander (SANTAN) in the end decided not to call their EUR 6.25 Perp 19 AT1 for economic reasons.  This is the first AT1 not to be called and, to some extent, this has come as a surprise to most investors.  However, purely from an issuer perspective, it makes complete sense.

Post the non-call, with a reset spread of 541 bps, this AT1 now should yield about 5.5% from next month. Initially post the non-call announcement, the AT1 dropped about 2 points and then bounced back and is trading close to par. This strange price action has opened up more questions than answers.

To some degree, this price action is a bit strange as one would have expected investors to take a dim view.  Valued as a true perp and assuming investors would demand 7% yield to own AT1s, this bond should have traded down to the low 90s cash price area and in a risk-off scenario, potentially trade even lower than that.

Why has it traded better than that?

The answer lies (to a large extent) in the fact that SANTAN can still call the bond once every three months from now on if they can replace it on better terms. Investors may be hoping that the overall spread on AT1 bonds will compress in a risk-on scenario and if it is called let us say in the next one year or so, owning this at 5.5% yield is not that bad relative to other HY issues out there.  For HY investors, a potentially short dated bond with 5.5% yield from a large European bank is still attractive.  

And they may like to ignore the tail risks embedded in the instrument. Given the dynamics on the potential call option feature, it becomes very difficult to short as well as the issuer holds all the aces.   And existing holders may well want to hold on and put some pressure back on the issuer and see if it can get called in coming periods.  Also, there is no real liquidity even if they wanted to sell.

It remains to be seen if SANTAN will call their USD AT1 in May 19, given the recent USD AT1 issuance.  Because the reset on the May AT1 is even lower than the EUR AT1 and the recent USD AT1, my view would be that they would not.  I believe that they issued the recent USD AT1 for a future increase in risk-weighted assets.

Will other issuers follow suit?

In my trade idea piece a couple of weeks back I referred to the following and I believe they still hold.   I personally think the bonds are unlikely to be called as most large European banks have indicated that call decisions on subordinated debt would only be on an economic basis:

  • For most large EU banks, the cost of issuing a new AT1 in EUR would be around 6.75%-7%, much higher than the reset coupon on most existing AT1s
  • The additional interest cost on a new AT1 Issue may be 100 bps only and that on a EUR 1 billion issue amounts to EUR 10 million a year. But if the bond is a perpetual instrument and not called for, say, 10 years, the savings in interest costs is around EUR 100 million
  • EU bank investors have endured significant pain in the form of equity price decline and that may influence management approach to call decisions
  • Whilst SANTAN may be first EU bank not to call AT1s, it may not have a huge impact on their ability to tap capital markets for other debt issues given expectations have changed for sub debt instruments. Other banks are likely to follow suit as well and make similar call decisions.


Given that SANTAN (one of the larger issuers amongst the European banks) has not called, the stigma associated with non-calls is no longer to be a factor for other banks and I believe that most of them will follow suit and make call decisions based on economic rationale.

That means it will boil down to the reset spreads, financing conditions and need to preserve loss-absorbing capital.  The re-pricing of the short-dated AT1s from a yield to call to a yield to perpetuity is going to cause significant price volatility and with limited secondary market liquidity, we may yet see a big shakeout.

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.