(Bloomberg) -- European banks have turned to the US dollar market to sell almost $8 billion of bonds that help them boost capital levels. Investors hunting for higher coupons want even more.
Sales of the debt known as AT1s, designed to absorb losses when a bank runs into trouble, are running at a record pace and include deals by Barclays Plc, Spain’s BBVA, and UBS Group AG. Demand has been more than eight times supply on occasion, highlighting money managers’ thirst for yield as spreads for most forms of debt continue to grind tighter.
Selling the bonds in the US makes sense for both banks and investors because of the different metrics they use to measure value. Banks are deciding where to sell based in part on risk premiums — the extra amount of yield they’ll pay compared with safer government bonds. Tapping the US market gives Europe’s traditional lenders access to tighter spreads compared with euros.
Money managers are focusing on the yields the bonds pay, which are relatively high, often ranging from 7% to nearly 10%.
“For investors, the bigger coupons are always going to be attractive to lock in.” For issuers, we “are starting to see really skinny spreads,” said Julien Roman, a managing director at Bank of America Corp. “The tight spreads of low beta European bank dollar AT1s are still offering a hefty premium” to the preferred equity of their US peers, he added.
The interest in the hybrids comes as US banks are expected to face softer regulation following the election of President Donald Trump, meaning they may have to issue less preferred equity. That’s been a boon for European banks, which unlike their US peers need to meet much more stringent regulatory requirements, as they can take advantage of the gap left by US lenders.
The region’s banks have also proven resilient to falling interest rates and their shares have rallied in response to promised share buybacks, making them by far the best performer in European stock indexes this year.
Barclays became the latest European bank to tap the market this past week, selling a $1.5 billion AT1 and there remains as much as $23 billion of outstanding risky debt by European lenders that is first callable this year.
“Expect to see more issuance in the coming weeks amid the resilient backdrop with borrowers accelerating plans,” Roman at Bank of America said.
While the risk of a complete wipe out similar to what happened with Credit Suisse two years ago has receded, the tightness of the spreads at which the deals have priced has some investors worried about so-called extension risk. When it is time for the new bonds to be called, the spreads they reset to are so low that issuers might decide against replacing them.
“We are creating a cohort of AT1s with awful resets. The high coupons mask a larger extension risk down the line,” said Aegon Asset Management portfolio manager Alexander Pelteshki.
Still, European banks have a track record of calling and replacing deals at the first opportunity, a draw for investors. Only this week, both ING and Aareal said they were calling their AT1 debt due to be called in April.
Week In Review
On the Move
--With assistance from Taryana Odayar.