AT1 needs transparency, not more protection
Regulators and politicians have suddenly found the will to defend the additional tier one market — a market they created — from the violent shocks it experienced early this year. In particular, they want to give AT1 investors some reassurance about skipped coupons.
But the market chaos hit all of Europe's big banks, regardless of their relative abilities to pay AT1 coupons. That implies a repricing of the asset class, more than idiosyncratic fears over possible missed coupons.
As GlobalCapital reported at the time, AT1 paper sold off broadly, despite the possibility of a missed coupon, specifically by Deutsche Bank, being cited much in the press as the main culprit of the crash in prices.
Nationwide Building Society, which had an MDA buffer of 13.98% as of January 1 — the highest among AT1 issuers — saw its bonds sell off 10 points to about 82 in mid-February.
Meanwhile Deutsche Bank’s 7.5% dollar AT1s, having traded to a low of 72.29, is now trading at above 87. Deutsche Bank’s MDA cushion, at 2.44% isn’t the lowest in the European market — that dubious honour goes to UniCredit — but the actual amount of money it has to pay coupons (known as ‘distributable items’ and representing the amount of money it has to pay discretionary items without breaching capital buffer requirements) is right near the bottom, at €1.092bn.
That translates to a ‘coupon cover’ of only 3.2x, according to CreditSights. Nationwide, meanwhile, has a 125.3x coupon cover multiple.
If coupon deferral were the fear being expressed during recent volatility, then one would expect such bonds to trade differently, with the spread between the instruments closely related to the spare cash available to pay coupons.
Banks which look set to pay out scanty spare cash in dividends should also have been punished more harshly by the sell-off. But equity dividend ‘stoppers’ built into deals by the likes of UBS didn’t seem to abate the sell-off in those bonds, which fell in price by 8-9 points. UBS’s AT1s have, however, traded strongly enough since the last European Central Bank meeting to get a new, oversubscribed, deal done.
Nonethless, it looks like some policymakers believe now is the time for action on skipped coupons. A note sent to the European Commission’s expert group last week suggests that AT1 bondholders “deserve particular protection relative to the other stakeholders concerned”, since they can’t catch up – coupons are non-cumulative, and can’t be varied upwards.
But extra protection for AT1 risks several problems.
First, it risks further distorting the capital structure. Some argue that the place of AT1 in capital structure is already a distortion – equity style downside with a debt upside, but further changes would muddy the waters even further.
Second, AT1 coupon deferrals, particularly its non-cumulative nature, was built into the regulatory structure to keep coupon payments from exacerbating times of stress, and making sure they did indeed absorb losses — sceptical politicians are aware of this fact, and unlikely to want to return to the capital structuring wrangles which birthed the AT1 rules in 2013.
A much better move would be finally fixing the transparency problems which have dogged the market. Few investors have been clear how the various regulatory capital requirements interact with each other — indeed, bank finance officers and treasury official have struggled to keep up.
Support for making Pillar 2 (extra capital requirements added at supervisory discretion) more transparent has now come from European Central Bank president Mario Draghi, the European Commission, the European Banking Authority and the European Parliament.
Parliament is looking into potentially making maximum distributable amounts (the amount available to banks to make AT1 coupon payments, among other disbursements) less reliant on Pillar 2 compliance, and even giving banks the ability to appeal an authority’s Pillar 2 guidance.
Enhancing transparency in those areas is also of great importance to all investors, as well, since the rules directly impact capital strength and profitability.
That should be the focus of efforts in the future — simplifying the industry of banking and bank capital and making it fully transparent to the market. The buyer base is there, as demonstrated by the UBS deal. But the resiliency of the market depends on being clear about its rules.
We’d advise regulators stick to some advice they’ve been doling out to certain other allegedly complex markets:
Make it simple, standardised and transparent.