Three month par calls: a useful tool for senior issuance
Long call periods are now an established feature in bank capital products, but the benefits should also apply to the senior market, particularly when it comes to riskier borrowers beginning their MREL journeys.
Last week Permanent TSB, Nordea Bank and Virgin Money UK all included options to call their 10.25 year non-call 5.25 tier twos up to three months before their first reset dates. They were just the latest in a slew of issuers to embrace using longer call periods in tier two instruments.
With six month call options already commonplace for additional tier ones, banks should now be weighing up what they can do in the senior market as well.
A small number of borrowers have already incorporated three month par calls in their senior bonds.
De Volksbank, for example, used the feature as part of a €500m seven year non-preferred deal sold in green format in late February.
But it is the smallest and riskiest names that stand to benefit the most, because a longer call period would give them far more flexibility around when and how to refinance some of their most strategic deals.
Many infrequent issuers are getting ready to start issuing new types of debt for the minimum requirements for own funds and eligible liabilities (MREL), for example.
They have interim targets over the next couple of years, ending with a final deadline in 2024, and using a flexible call option could make life far easier for those wanting to keep a rolling stock of regulatory debt.
The feature could work in tandem with call options a year ahead of maturity, which are now commonplace in MREL offerings. But it could also work with bullet maturities, as de Volksbank demonstrated with its seven year print.
Of course, the three month call periods now customary in the tier two market are a far cry from the single date calls commonly found in MREL offerings, but even then, shorter two month or even one month options would still bring a benefit.
The point is that banks would not be forced to try to access the market within a small and potentially unfavourable issuance window — which could be impossible for all but the best-known borrowers.
Smaller firms would therefore not have to consider paying two sets of coupons on potentially net interest-eroding transactions.
There are concerns that including these sorts of options might increase the cost of debt for banks.
But in theory, three month par calls should work for investors too, because a longer window would improve the chance that a borrower calls rather than extends a note.
Indeed, of the three borrowers to pair a three month call option and a tier two deal last week, only Virgin Money UK paid any new issue premium, with the other two borrowers pricing their offerings flat to their curves.
With these smaller names, every basis point counts, especially with the volumes of senior MREL paper to come. Anything that makes the process easier for both investor and issuer is welcome.
There really is such a thing as a free lunch. Small banks must take full advantage of it while they can.