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Emerging Markets

Not calling only gets some a mauling

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The reason for a no call is an important detail. The rules of the game don't always apply when conditions are tough

As rates have flown sky high, several CEEMEA banks — most notably from Turkey — have broken an unwritten obligation to call bonds, throwing into doubt all issuers’ ability and willingness to honour call dates.

But predicting whether a bank will call or not requires a lot more than the bare reset numbers. And the resulting fall from grace would be far further for some than others.

Abu Dhabi Islamic Bank was set to print a $750m 7.25% perpetual non-call 5.5 year sukuk on Tuesday. While the bank has not confirmed to investors that the deal is intended to refinance a 7.125% AT1 callable in September of the same size, that has certainly been the assumption. Those bonds rallied to par. Investors were pleased and piled into the new issue — the first CEEMEA AT1 this year.

Investors threaten fire and brimstone in the form of pricing future deals to maturity if an issuer does not honour a call date. When these deals are printed, they are sold with issuers expecting the notes to be called. While there is no contractual obligation for a borrower to call, consensus suggests that there is a moral one.

But the reality is more nuanced than that. For example, in the cases of the Turkish banks that have not called in the last year, it has become increasingly apparent that it is because they really cannot afford to. Refinancing rates would potentially be hundreds of basis points different to the originals, as the Turkish economy faces huge internal challenges, sky-high inflation and is grappling with the rise in US rates.

In some ways, it can be argued that by not being triggered, call options are being used as intended — to support the banks when times have become tough — and so it is difficult to see how an investor could feel betrayed by such results. They may feel sore at the loss, perhaps stupid or unfortunate, but not hoodwinked.

For Abu Dhabi Islamic Bank, the psychological calculation is different. Rates may be up because it is more expensive to refinance, but business is booming as it sits inside one of the largest oil-producing countries in the world. It may be economically inefficient for the bank to refinance its AT1, but it can definitely afford to do so without the risk of being brought to its knees. But refusing to call in September in order to save a few bucks, would be a real blow to its reputation.

In the end, the feeling that would cause would be of being cheated, and it is easily conceivable that some investors would steer clear of the issuer in the future or insist on pricing future callables to maturity.

Instead, ADIB was praised this week for making — what is assumed to be — the first step to calling its September bond. But the bank knew that its stakes were higher than for many other banks in the CEEMEA region. It was right to notice that the rules of the game do not apply to everyone in the region.

Rather than look to follow in the shoes of their Turkish counterparts, other fortunate issuers with similar fortunes to ADIB would do well to take heed of the Islamic bank.

Sometimes it’s tough at the top.