24th January 2019

Want a nice trade to play SANTAN AT1 call decision? | Trade Ideas

Will they or won’t they?  SANTAN due to make decision on EURO AT1 callable in March 2019

Banco Santander (SANTAN) is due to report Q4 2018 earnings on 30 Jan 2019.   More importantly, for the bank capital market, would be the likelihood of a call decision on their 6.25% EUR AT1 (which is callable on 12 March 19).

Currently it trades with a cash price of €97 and if called at par, it translates to 3 points upside for 6 weeks risk.  But, if they don’t call, these bonds may drop to €90 or a lower cash price area..

potentially with a drop of 7-10 points to reflect perpetual risk (assuming investors demand  6.5% yield to perpetuity.  Given this situation, being long the bonds may result in a 3 point upside but also expose to a potential 7-10 point downside.


We don’t think they will call…

I personally think the bonds are unlikely to be called as most large European banks have indicated that call decisions on subordinated debt would only be on economic basis:

  • Cost of issuing a new EUR 1.5 billion AT1 would be around 6.75%-7%, much higher than the reset coupon (5 year mid swaps + 541 bps).
  • The additional interest cost on a new AT1 issue may be 100bp only and that on a EUR 1.5 billion issue amounts to just EUR 15 million a year. But if the bond becomes a perpetual instrument and say not not called for 10 years, the savings in interest costs is around EEUR 150 million.
  • SANTAN’s shareholders (like most other EU bank investors) have endured significant pain in the form of equity price decline and that may influence management approach to call decisions especially on AT1s.
  • Whilst SANTAN may become the first EU bank not to call an AT1 issue, it may not have a huge impact on their ability to tap capital markets for other debt issues given expectations have changed for subordinated debt instruments. Other banks are likely to follow suit as well and make similar call decisions.

And directionally shorting these bonds at 97 cash price is not a good idea either.


Is there a better play going into this decision?

I believe that there is a better way to play this:

LONG the SANTAN 6.25 EUR Perp March 19 Call at 97 and SHORT the Barclays 6.25 EUR Perp Sept 19 Call at 99 cash price

Rationale:

  • It seems highly likely that both the bonds will not get called given the resets – SANTAN’s reset is MS+541 bps and Barclays’ reset is MS+587 bps.
  • My personal view is that a new SANTAN PerpNC5 AT1 in Euros will probably price around 6.75%to 7% whilst a new Barclays PerpNC5 in EUROs will price closer to 7% to 7.25% reflecting higher risk premium for Brexit and investment banking business.
  • Structurally SANTAN AT1 is slightly better than Barclays given the trigger event (conversion to equity) is if CET1 drops to 5.125% for SANTAN and it is 7% for Barclays.  For both it is highly unlikely that the trigger event occurs but the lower CET1 trigger for SANTAN just makes it better to own.
  • SANTAN’s potential non-call decision will impact all other short call bonds and hence Barclays likely to drop as well.  If SANTAN do not call, I see both bonds drop to the 90s or lower cash area, in which case the overall drop in Barclays AT1 bonds would be higher than the SANTAN AT1.
  • If SANTAN do call the AT1 at par, you end with up 3 points of upside as Barclays bonds are likely to be unchanged until their decision to call or not call.
  • In addition this trade allows additional optionality to potential chaos on no deal Brexit.
  • Finally, any negative headline or event risk on DB will have bigger impact on Barclays AT1 valuations.

Conclusion:

SANTAN 6.25% EUR Perp 19 AT1s look attractive to own given the valuations but the call decision is a binary risk to make.  Hence a relative value trade with limited downside is a better way to play into this event risk.


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.