Learning to live with CoCo non-calls

Completed on 15| 03 | 2022

We have been asked lately whether there would be some non-calls on Additional Tier 1 CoCos for the months to come and whether higher rates/yields were an obstacle to the refinancing of AT1 CoCos. Our short answers to these questions are respectively: 1/ yes, non-calls are to be expected, and it is quite a non-event actually; and 2/ No, what matters is the spread on CoCos, not their yield or the level of core rates. Let’s focus on these matters to demonstrate why non-calls are set to become more and more common and why it is not an impediment to the performance of the bonds, nor is it to their carry.

1/ How do AT1 CoCo calls work?

a/ The economics of calling a CoCo bond

AT1 CoCos are regulatory instruments that count as Tier 1 capital (hence their name!) and that need an approval from the bank’s regulator in order to be called. Basically, bonds can be called only as long as they have been refinanced already at a lower or similar cost or if the bank has replaced them with an equivalent amount of higher quality capital (i.e., common equity). As such, there is no direct incentive for the issuer to call the bond if it has not been replaced by a similar capital instrument. 

Issuers usually strive to refinance their CoCos whenever they can, sometimes as much as 6 to 12 months before an upcoming call date. Their idea is to secure the funding on a new bond at a similar or lower cost than the existing instrument while assuaging investors about the exercise of the call on their existing CoCo. Santander had failed to refinance one of their CoCos back in Q1 19 and therefore had to extend it (they eventually called it afterwards when they could refinance it at a lower cost). Non-calls usually happen some time after or during a period of market stress, when issuers cannot properly access primary markets at a decent cost. That is what happened during the Covid-19 crisis, when Deutsche Bank, Aareal Bank and Lloyds Banking Group decided to not call their respective AT1 CoCos in Q2 2020. In order to avoid the potential price friction on an upcoming call, several issuers have included within their documentation the possibility to call the bonds during a 6-month call window rather than on a specific day. This is a welcome documentation adjustment, but that will solely apply to issues whose call dates are far from now since it was first introduced back in 2019.

Breakdown of calls and non-calls on AT1s from European banks¹

	2018	2019	2020	2021	2022
Number of bonds	4	13	22	18	22
- called	4	12	19	18	9
- not called	0	1	2	0	0
% called	100%	92%	100%	41%
Total amount of AT1s called ($bn)	6.475	15.2	23.8	24.3	7.7

 ¹Sources: Bloomberg, La Française. Data as of 15/03/2022.