Investors in the riskiest bank debt in Europe were stung by losses in March as the fledgling market more than doubled in size.
The bonds forfeited 0.2 percent last month, the first period of negative returns since Bank of America Merrill Lynch starting tracking contingent capital securities on Dec. 31, as notes from Societe Generale SA and Credit Agricole SA lost more than 1 percent. European lenders issued the equivalent of $16.5 billion of securities that comply with new regulations governing capital requirements, making March the busiest month since the first bond was issued last April.
Regulators’ efforts to ensure bank investors are on the hook for failing lenders have created a new class of high-risk junior bonds explicitly designed to incur losses without defaulting. The market has swelled to more than $30 billion in less than a year, a size Europe’s junk bond market took almost five years to attain, as the coupons issuers pay to compensate for the risk lure investors.
“Indigestion is what’s on everyone’s mind,” said Steve Hussey, a London-based credit analyst at AllianceBernstein Ltd. “Leads need to be aware of the danger of establishing unrealistic price levels and of the negative sentiment that would be created if and when there’s a pullback.”
Average yields, which dropped to as low as 6.32 percent on March 6, ended the month at 6.60 percent, according to Bank of America’s High Yield Contingent Capital Index. That compares with an increase of one basis point to 1.51 percent for senior bank debt, which returned 0.4 percent in the same period, Bank of America’s Euro Senior Banking Index shows.
The average coupon on the 10 additional Tier 1 notes sold last month was about 6.81 percent, compared with an average of 8.36 percent on the nine preceding transactions, according to data compiled by Bloomberg.
Additional Tier 1 notes convert to equity or are written down when the issuer’s capital falls below a pre-set percentage of assets. The securities differ from more-senior Tier 2 bonds because they don’t have a maturity date and borrowers are allowed to skip interest payments without defaulting, meaning holders risk ending up with an undated note that pays no interest.
Societe Generale’s $1.75 billion of 7.875 percent bonds fell 2.5 cents on the dollar last month to 104 cents, while its $1.25 billion of 8.25 percent debt declined 2 cents to 108 cents, according to Bank of America prices. Credit Agricole’s $1.75 billion of 7.875 percent bonds fell 2 cents to 105.6 cents.
When Banco Bilbao Vizcaya Argentaria SA issued the first additional Tier 1 bonds in April last year, it offered a 9 percent coupon for $1.5 billion of notes. Last month, KBC Groep NV raised 1.4 billion euros ($1.9 billion) of 5.625 percent securities, the lowest coupon to date, while BBVA returned to the market in February with a 1.5 billion-euro sale of 7 percent notes.
“Pricing of the new issues got a bit too keen, given the still-uncertain risks in the debt,” said Oliver Judd, a London-based analyst at Aviva Investors Ltd., which manages the equivalent of about $410 billion. “It’s gone from being a brand new market in the second quarter of last year to being relatively expensive now.”
Credit Agricole is offering its second sale of additional Tier 1 notes today. France’s third-largest bank plans to sell 1 billion euros of bonds that are being marketed at a yield of about 6.5 percent, according to a person familiar with the matter. It also plans to issue 500 million pounds ($832 million) of securities to yield about 7.5 percent, according to a person familiar with the matter.
The Paris-based lender’s $1.75 billion of capital securities issued in January pay a coupon of 7.875 percent. They are trading at 106 cents on the dollar to yield about 7 percent, according to Bloomberg bond prices.
Banks are eager to issue additional Tier 1 debt because existing capital notes might not be counted under new regulations. The European Banking Authority is also coordinating stress tests designed to ensure lenders are able to survive a major crisis without taxpayer support.
“Some of these things are very high risk and investors need to be compensated for that,” said Ariel Bezalel, who manages the equivalent of about $3.1 billion at Jupiter Asset Management Ltd. in London. “These bonds can sell off pretty quickly.”
Germany, Europe’s biggest economy, is working to accommodate additional Tier 1 bonds in its tax code. Deutsche Bank AG, the nation’s largest lender, said in October it plans to issue 5 billion euros of the securities once their tax treatment is clear.
Taking that into account, issuance this year will “easily” reach 50 billion euros, according to Mark Holman, chief executive officer of TwentyFour Asset Management LLP in London, which oversees about $3.9 billion of fixed-income assets.
“I’d be surprised if any major bank wasn’t considering issuing,” said Holman. “There’s a huge amount of supply that wasn’t there last year, huge. It’s high yielding, it’s volatile and it’s a trend.”