AT1 calls - another one bites the dust

Earlier today, Julius Baer announced a call of its $300m Additional Tier 1 (AT1) instrument. The bond had a coupon of 4.75%, and if not called it would switch to a new coupon of five-year Treasury yield plus 284 basis points (bps), so about 6.7% at the moment. We estimate that the fair value replacement cost for the issuer would be closer to 8%. In other words, the call was strictly speaking ‘uneconomical’ and if not redeemed the bond could have traded lower – the exact price impact would likely be reduced by the frequent call schedule post the initial redemption date. The latest development is particularly interesting, as comes after a patchy period for the issuer, which somewhat elevated the cost of refinancing its debt instruments.

In this context, there are a few points we thought are worth noting.

Firstly, this is not the first time a European bank called its debt instruments below its replacement level. Indeed, this is just yet another example of this behaviour. We discussed this on multiple occasions and last time earlier this year – see here. It is important to highlight though that this particular AT1 had a reset of five-year US Treasuries +284 bps – we estimate that only about 1% of AT1s have a reset that is same or lower than this.

Secondly, while this is not the first time that an out of the money call did happen, we think it is important as it adds to the track record for European banks and creates incremental pressure on other issuers not to deviate from this practice. While there will always be some exceptions to this rule, the call at this point is also important, as we are heading into vintages of AT1s which are callable in 2025 and 2026 – these bonds often have lower resets than those that have been callable until now.

Thirdly, we think it is important to see this call considering how far out of the money the reset was. Indeed, we have seen issuers in the past calling AT1s generally up to 100 bps out of the money. There were some exceptions where wider levels also happened. There is no specific level of what is generally acceptable as “wide enough” to justify extension. Julius Baer calling the bonds about 130-140 bps out of the money stretches this theoretical boundary and sets a precedent for other issuers to follow.

Finally, in our opinion, we do not think European banks are behaving “uneconomically”. Indeed, we would argue that the actual reset level is just one of the components in a decision that is taken into account, there are other components; such as market practice, reputational risks, ongoing access to the debt markets, the need for capital at any given point, and many other considerations. The message here is that we believe issuers are very much focused on their interests when making call decisions, it is just that the level of reset is one of the many components being taken into account – the current levels are not quite low enough to outweigh other considerations.

All in all, one swallow doesn’t make a summer and we do not want to overstate the importance of this single call in isolation. At the same time, we take comfort in seeing that the intentions for the call remain incredibly strong for European banks. This call by Julius Baer also contributes to the European track record and puts pressure on other issuers to follow, therefore further increasing the importance of other, non-reset specific considerations when making the call decision. Indeed, we see this latest development, more as a re-affirmation of a broader trend we are observing, which should continue to support AT1 valuations versus other credit alternatives.