9th January 2019

Food for Thought Idea in USD AT1 Land | Bank Capital

HSBC 6% Perp 27 AT1 looks very attractive relative to STANLN 6.5 Perp 20 AT1

Macro background:

  • USD swap rates continue to widen especially in the front end and we continue to see the curve flattening
  • Global growth is slowing down but with potential sticky inflation (oil/commodities driven). Trade wars, protectionism and increasing geopolitical risks are going to create volatile moves in markets
  • EM currency and hard currency debt is coming into focus given the record level of issuance in recent years
  • Repricing risks in new issues and new issue markets being shut
  • Potential end of global easing and accommodation
  • Diminishing appetite for risky assets

However, as mentioned in earlier posts, credit may be an unexpected beneficiary as central banks add lifelines to global markets.  Hence the need to be in defensive names which are likely to hold up relatively well through this volatile period of adjustment.

Given above, my idea would be to go long in one of the strongest banks in Europe with solid fundamentals and a diversified balance sheet with good capital, asset quality and liquidity metrics and be short in one of the biggest EM plays with significant headwinds.


Rationale:

In my opinion, the AT1s issued by HSBC are likely to be more defensive than the ones issued by Standard Chartered Bank (STANLN).

Also, in my view, HSBC has a much better risk profile than STANLN in every metric. STANLN is still a restructuring story with significant EM exposure especially in the Middle East and India.

  • HSBC AT1 is IG rated at 2 agencies (Baa3/BBB-) while STANLN AT1 is sub IG at the 3 agencies (Ba1 / BB-/ BB+)
  • HSBC USD supply over given recent jumbo $4 billion issuance. STANLN has to issue AT1 and/or refinance existing AT1 and that too in USD (given balance sheet is USD)
  • HSBC 6 has traded 2-3 points higher than STANLN in the past 12-18 months and is now trading 5 points lower. Expect relationship to normalise back to unchanged or STANLN to trade lower than HSBC.  Upside in trade is about 4-5 points with limited downside risk of 1 point
  • HSBC equity has vastly outperformed STANLN over the last 12 months and is likely to do so going forward
  • Valuation-wise – HSBC 6 AT1 trades wider than STANLN 6.5 AT1 purely due to duration risks and the perception that STANLN will call the 2020 bond. But given that a new AT1 would cost the bank the same as the existing one, they may not call (STANLN call their sub debt bonds purely on economic basis and they have not called legacy Tier1s)
  • STANLN COE should be around 11% (so theoretically AT1 yield should be around 8.5% yield adjusted for tax benefit) while HSBC COE is potentially around 9% (and theoretically AT1 yield should be 6.5%)
  • In both cases, coupon suspension and conversion triggers are remote and subject to the same UK regulations HSBC dividend yield is almost 6% and STANLN is 2% with potential for dividend to be suspended again
  • Both bonds are highly liquid (HSBC 3 billion issue and STANLN is 2 billion issue)
  • HSBC reset on non-call is 5-year swaps + 3.746% and STANLN reset is 5-year swaps +4.89%.  A new STANLN 5/7 year USD Perp AT1 would price around 7.75% (MS + 500) and that too if market conditions are favourable and investors want EM exposure
  • There is a general perception that there are plenty of PB investors in STANLN 6.5 AT1

Conclusion

In general, the HSBC USD 6 Perp 27 AT1 bond looks attractive to own at 94 cash price on a yield to call (and even as a true perp) and is a good defensive bond to own.  I think being long the HSBC 6 USD Perp 27 at 94 cash price versus short the STANLN 6.5 USD Perp 20 at 100 cash price is one of the better relative value trades out there.

PS – for detailed rationale and data analysis to support the above idea please reach out to us to discuss.


For information about our bespoke portfolio risk service, click here

GJ Prasad

A senior European bank research specialist with significant breadth/in-depth sector knowledge, GJ has researched bank capital instruments extensively - having covered the asset class for more than 15 years as an analyst and 7 years as a risk taker in buy-side roles. His specialisation includes carrying out detailed financial modelling work on the European banks focusing on asset quality, earnings and capital adequacy metrics. His deep-dive work focuses on single name selection and extensive risk analysis on capital securities, especially on structural features, issuer credit profile and equity/AT1 valuation.

%d bloggers like this: