18th January 2019

You want yield but from “Almost safe bank”? | Bank Capital Insights

What yields 8.5% YTC and 6% YTP and is issued by the “most defensive” European bank?

In the land of the high yielding USD AT1s, a number of issues appear very attractive to own given cash prices and recent sell off.  Out of that lot, a couple of issuers stand out given their strong balance sheet, low risk business model and are shielded from most tail risks.  One such name is UBS which reduced the reliance from the volatile FICC units to more stable wealth and asset management businesses.   The UBS 5 Perp 23 AT1 in USD…..

…currently trading with a cash price around 87 (up 4 points in the last 10 days) stands out as the one of the best AT1s to own and hold.


Buy UBS 5 Perp 23 at 87 cash price

Trade rationale*:

  • Translates to yield to call of 8.5% and almost 6% on a yield-to-perp (YTP) basis.
  • If called in 2023, potential 13 points of upside from current levels.
  • Clearly, the biggest risk is non-call in 2023, at which stage the coupon becomes a floater (MS + 243.2 basis points). But, if USD swap rates keep climbing, owning this bond is still attractive given the almost 6% yield for ever.
  • UBS AT1s are amongst the few bonds that may see IG ratings at two or more agencies. It is already rated BBB- at Fitch.  If it were to be rated IG at all agencies, expect the IG funds to add to their portfolio.
  • AT1 bucket almost filled and almost no more issuance expected.
  • The current AT1 yield is much higher than the current dividend yield (4.8%) on the bank’s stock.

Strong fundamentals

UBS fundamentals look very strong – CET1 ratio of 13.5% the best in class amongst the large cap global banks.  The bank generates almost CHF 5 billion in annual earnings translating to ROCET1 of 16% which is significantly higher than bank’s COE.

Extremely unlikely that the trigger mechanism would come into play – both on coupon suspension and conversion to equity given the very high CET1 ratio and buffers.

  • One of the most defensive plays in Europe given the very large asset management and private banking business and a low risk investment bank that is focused in equities and advisory business.
  • Not impacted by the current tail risks impacting other EU banks.
  • Deep dive stress test on this name sees very small drop In CET1 ratio reflecting strength of its balance sheet.

Conclusion

Potentially, I see this bond trading in the low 90s cash price over the next few months and hence an upside of 4-5 points from here.   And if it drops back to low 80s cash price it would be even more attractive to own.

And this bond should be very attractive for HY investors given the yield pickup to other HY corporate issuers. Would one want to own UBS AT1 or cyclical HY issuer for similar yield and/or same rating?


* As usual, the above reflects my personal views on the above trade idea and would be happy to discuss the rationale in detail.  Please reach out to me for a discussion on the same, if needed..

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.