Macro Strategy

Non-call risk and Asian AT1 bonds, Singapore’s 2019 budget
Neel Gopalakrishnan, Joanne Goh15 Feb 2019
    Photo credit: AFP Photo

    Credit: Asian T1 CoCos have lower risk of non-call

    Banco Santander’s decision this week to not call one of its perpetual Tier 1 securities highlighted once again the risk in investors assuming that banks, as market practice, would call these securities on the first call date. Our analysis of Asian Tier 1 bonds callable in 2019 and 2020 shows that the risk of non-call is low at the moment due to two reasons: first, limited economic incentive for the issuer not to call, unlike in the case of Santander; and second, still favourable issuing environment for banks in Asia.  

    Of the seven CoCos (aggregating around USD10bn) callable in 2019 and 2020, all seven bonds would see an increase in coupon by an average of 0.9% from current levels (or 15% relative increase). Besides, the increased coupon would be quite similar (or even lower) to what the banks would need to pay for a new Coco if they issued one now. For example, the China Citic Bank 7.25% Tier 1 bond (Ba2 hyb) callable in April 2019 would see the coupon step up to 8.1% if not called. The bank’s  7.1% T1 bond callable 11/2023 is currently indicated at around  6.2%.  Also, as a comparison, CMB Wing Lung Bank (Ba1 hyb) issued a Tier 1 bond in January this year at 6.5% with the bond now trading at a YTC (1/2024) of 6%. On the other hand, the coupon on Banco Santander’s 6.25% T1 (which it did not call) fell to around 5.6% (due to a decline in the benchmark EUR rate), and much lower than its current funding cost (the bank issued USD1.2bn of T1 notes at 7.5% on 6 February). Hence, unlike in the case of Santander, the Asian banks do not have an economic incentive to not call their T1s at this point in time. The Asian banks’ fundamentals are also supportive of the bond redemption with the average CET1 ratio of the issuers with bonds callable in 2019-20 being around 12.4% (only one issuer (China Citic Bank has a CET1 of less than 10%).  Fundamentals were, however, not a reason for Santandars’ non-call either.

    As an aside, we believe the non-call of Santander’s T1 has also reminded market participants of the flawed assumption that banks would call their capital securities at the first opportunity, irrespective of economic considerations. Whereas in reality, banks are under no contractual obligation to redeem the bonds and the call is an option that they may choose to exercise. The argument of reputational damage in the event of non-call will not hold, especially as incidents of non-call become more common. In the past, banks that have chosen to extend capital bonds have been able to access the markets fairly soon after. The non-call is also a reminder that investors have to adequately price in the risk of extension at the time the bonds are priced.
    Equities: what to watch for in Singapore’s 2019 budget

    Singapore’s 2019 Budget, to be announced next week,  could touch on three areas: (1) review of existing guidelines pertaining to skilled foreign workers; (2) preparing Singaporeans for the future via upgrading of skills, education and healthcare investment, strengthening social safety net; (3) helping companies venture regionally.  Investors are advised to keep watch on risk in the residential property sector. As foreign “PMETS” (professional, managers, executives and technicians) are a major source of demand for rental properties in Singapore, demand will be adversely affected if there is a tightening in that space.  This could further affect demand for property and hence property prices which have been facing headwinds from higher interest rates and property cooling measures since last year. 

    Beyond this, we think the budget should be positive for consumer sentiments.  Household and SME subsidies have become a main part of policy guidelines and implementation to help them cope with rising costs and upgrade the nation. An election year drawing near should also keep domestic sentiments fairly positive, in our view. 

    Neel Gopalakrishnan

    Credit Strategist – Emerging Markets

    Joanne Goh

    Regional Equity Strategist

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