Calls can buy bond market reputation
By redeeming its AT1 bond early, UBS has gained a handy advantage over its local and international competition
Reputation is indispensable in financial markets. Last week when UBS announced its intention to redeem one of its most subordinated, yet one of its least expensive, debt capital instruments, it gained some serious street cred.
The Swiss bank sent something of a positive shockwave across the financial institutions bond market when it said it will call the $2bn additional tier one (AT1) bond early. It was an expensive decision that must have pleased many investors, even those not holding the debt, considering the bond was one of UBS' least expensive debt capital instruments on a relative, and more importantly, absolute spread basis.
The bond was issued in 2018 at a yield of 5%. Had UBS not called it the paper would have reset in January to a spread of dollar mid-swaps plus 243.2bp. That meant an equivalent yield of around 6.125% as of Tuesday.
Even the most aggressive estimate, as of last week, predicted that UBS had to pay a price of at least 115bp more than the reset spread of the called AT1. Moreover, the reset spread ranks among the lowest among major banks’ outstanding AT1 bonds and was also the lowest of the $25bn-equivalent of AT1 debt in dollars, euros and sterling with first call dates in 2023. (See table below)
It should have been a breeze for the Swiss bank to simply extend the bond, at least until the next call date in 2028, and in light of spreads and new issue concessions remaining high, despite more than a month of a credit rally, it would have been a nothing decision.
However, UBS chose not to extend. Instead, it chose to call.
In a statement, UBS said that: “[The] decision reflects UBS’s long-standing call policy, which is to carefully evaluate all relevant factors, including the market environment, economic costs, business growth and funding plans, as well as the current and future regulatory value of the capital instrument.”
For now, the bank has made the decision not to immediately refinance the AT1 bond given its strong capital position. But there is a very important takeaway to glean from this — by exercising the call UBS sends a very positive signal to the broader market, for multiple reasons.
Firstly, UBS is showcasing that it has excess capital to pay back investors. As of the end of the third quarter, it had a common equity tier one (CET1) capital ratio of 14.4% compared to the regulatory requirement of 10.3%.
AT1 bonds are structured with a call option, giving the expectation that issuers will redeem the debt early, though the bond will remain fully eligible as capital even if not called. Exercising this call has often been seen as “a gentlemen’s agreement”, but as spreads and new issue concessions remain elevated, many had started to expect, before UBS's call, that a major European bank may not redeem it early for an uneconomic reason.
By electing to call, UBS has now built some goodwill with investors and passed the burden to rivals.
The move gives the Swiss outfit first mover advantage among major European lenders by calling a low reset AT1. Whichever bank comes next will have the added pressure to do the same.
HSBC is next under the spotlight with its $2.25bn 6.5% AT1, which is callable on March 23. The bond has a reset spread of mid-swaps plus 345.3bp , making it the second lowest reset of the AT1s due for early redemption next year.
In addition, the call could give UBS a local uptick when it comes to wealth management clients.
While rival Credit Suisse was busy raising more expensive equity capital, UBS was handing back capital to investors.
This is a clear distinction that will matter to private banks and high net worth individuals, investor areas in which the Swiss banks have excelled and are striving to serve. These investors are crucial because they can move significant amount of funds across asset classes.
Additionally, AT1 debt is often sold into such accounts. Holders of the bond must have been brimming with joy to hear the news that UBS will return their money in January, allowing them to reinvest in higher yielding products.
In the future, UBS can then count on these accounts and their goodwill from the reputational gain. This may be when it comes back to the market to sell a new AT1 to refinance with a new capital deal — which some investors told GlobalCapital was only a matter of time last week — or if it wants to attract new funds to its name.
Reputation matters in finance. It may be hard to quantify at times, especially in good times, but it serves as a distinguishing factor.
UBS, a household name in wealth management, should now be more than capable of monetising this reputational gain and turning it into a distinguishing edge against both local and international competition.