Tier 1 bonds rocked after Credit Suisse call threat

Thu Feb 6, 2014 3:41pm EST

* Credit Suisse old style Tier 1 bonds sink on call risks

* Banks could follow corporate lead and break market taboo

* Issuers weigh up cost benefit of old style bonds

By Aimee Donnellan

LONDON, Feb 6 (IFR) - A second warning shot fired by Credit Suisse on Thursday that it might retire a hybrid Tier 1 bond early sent the price of the issue tumbling and left the market on edge about whether other banks will go down the same path.

The Swiss bank's 7.875% USD1.5bn Tier 1 bond dropped 3.5 points on expectations it will take advantage of a clause allowing it to call the transaction early due to the loss of regulatory or rating agency benefit.

As those calls tend to be at par or 101 - well below where the bonds are generally trading - investors stand to lose money, and analysts have already singled out Deutsche Bank and Lloyds as potentially doing something similar.

Although some investors are up in arms, bankers said they should not have been surprised by Credit Suisse's tough talk on an earnings call Thursday, especially as the bank had already flagged the potential move around a year ago.

"A regulatory call for partial loss of treatment is pretty clear in the Credit Suisse terms and investors happily bought into it at the time," said Daniel Bell, head of EMEA DCM capital products at Bank of America Merrill Lynch.

"It is about allocation of the risk of regulatory changes."

He predicted a backlash from investors if Credit Suisse does decide to exercise the call.

"We may start to see investors looking to shift the risk back to the issuer by asking for a premium call price on bonds that carry regulatory call options, particularly for partial loss of treatment."

TOUGHER STANCE

So far, banks have been loathe to exercise their right to call from fear of raising the wrath of investors. Indeed, issuers such as Danske and Societe Generale have opted for safer liability management exercises instead to meet investors half way.

Both offered slight premiums over where their bonds were trading to retire Tier 2 issues that had lost almost all of their equity content with S&P - even though they could have called them at par.

But analysts at CreditSights have already warned that banks might not be quite as lenient going forward. They reckon there is a higher probability of bond calls in 2014 than in previous years as bonds with coupon step-ups will drop out of regulatory capital at the first call date.

The idea of an early call has certainly caused some anxiety in the investor community - where hopes were that banks would stick to a friendly approach - and some are now reassessing the risks.

"In general investors are very concerned about banks calling bonds early for regulatory reasons," said Dierk Brandenburg, a senior bank credit analyst at Fidelity.

"If Credit Suisse were to go for an early call option as opposed to a liability management approach, it would be deemed very aggressive by the market and there is a fear that other banks would follow suit."

WHO'S NEXT?

Some question why banks would choose to keep the peace with investors when corporates such as Telecom Italia and ArcelorMittal have already called hybrid issues well below where they were trading, and without any sweeteners. [ID: nL5N0KV1IM] .

Deutsche Bank is seen as an obvious candidate to call, although analysts say that it will at least wait until Germany has an agreed Additional Tier 1 structure.

Once that comes, Deutsche could threaten a regulatory par call against an aggressive LME of their Tier 1s into new AT1, according to Morgan Stanley analysts, who say the bank is looking to raise EUR5bn in AT1 debt by 2015.

Others, though, say the situation isn't quite so clear cut, and that Credit Suisse may not be so quick to call its old style instruments.

According to one liability management expert, certain issuers are weighing up the cost of maintaining these instruments as essentially Tier 2 debt rather than retiring them.

"A bank might still think it worthwhile to keep a bond outstanding as a loss-absorbing or bail-inable instrument, or even simply as cheap long-term funding," said CreditSights analysts.

Meanwhile, another analyst speculated it could have been a clever manoeuvre by Credit Suisse to avoid paying over the odds to buy the bonds back.

"They may have floated the idea of an early call out to the market so the bond prices fall and they can launch a more cost-effective liability management exercise," said Christy Hajiloizou, a credit analyst at Barclays.

"The issuer is likely to be looking at a number of scenarios, talking with investors to decide on the best course of action, including the potential of an early call."

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