Banco Santander Feels Bondholder Heat After Skipping CoCo Call (Is The Spanish Banking Armada Sinking?)

It appears in Euroland that another bank bites the dust.  Or is struggling.

(Bloomberg) — Banco Santander SA reminded investors that juicy bonds can come with nasty surprises.

The Spanish lender rattled the bank Additional Tier 1 market by saying it will skip an option to call 1.5 billion euros ($1.7 billion) of perpetual contingent-convertible notes next month, sending the bonds tumbling. The announcement came late Tuesday, right at the deadline for a decision, after the bank kept investors in the dark for weeks regarding the call option and in the aftermath of another deal, a sale of dollar AT1 notes on Wednesday.

“The handling of the situation was truly disastrous,” said Timothee Pubellier, a portfolio manager at Financiere de LA Cite SAS, which holds Santander CoCos. “Credit investors will need some serious new issue premium to touch that name again.”

The Spanish bank opted against a call due to an “obligation to assess the economics and balance the interests of all investors,” a company spokesman said in an email. “We will continue to monitor the market closely and will seek to exercise call options where we believe it is right to do so,” he said.

The euro AT1s tumbled to 97 cents on the euro following the announcement. The notes traded at almost par last week when the dollar CoCo sale stoked optimism for a call.

The decision to skip the call may drive up costs across the market for the regulatory-driven bank bonds as investors have traditionally priced CoCos in the expectation that they will be called at the first opportunity. It may also tempt other banks to follow suit, presenting a looming market risk as the number of AT1s with low post-extension rates approaching their first call dates will pick up into next year.

“This is very surprising and it is a really bad news for CoCos, specially for those that have low coupon for the first call,” said Alfonso Benito, chief investment officer at Spanish asset manager Dunas Capital. “The market is going to request additional premium for this kind of product in the future.”

The yield to maturity on the euro AT1s widened to 5.7 percent after the non-call announcement. The bank’s dollar AT1s with a May call option slipped to 97.8 cents. Its American depositary receipts traded slightly higher in New York, climbing 0.7 percent to $4.55.

Skipping the call may work out cheaper for Santander than redeeming the notes and selling new ones because the floating rate after extending the existing notes is lower than current market-funding costs. Against that, the bank had to weigh potential reputational damage that could drive up borrowing costs across its future subordinated issuance. Other banks will have to make similar calculations in the months ahead.

Banks have rarely broken with convention on calling subordinated notes at the first opportunity. Deutsche Bank AG roiled credit markets in 2008 when it skipped a call option, triggering investor losses. Assumptions were shaken again in 2016 when Standard Chartered Plc and German lender Commerzbank AG extended similar notes.

Market Maturing

For some, the decision had merits. Redemption is voluntary and regulators gave banks no extra incentive to call the notes as they didn’t include a guaranteed coupon step-up in the design of the notes.

This is a “sign of the market maturing,” said Steve Hussey, head of financials research at AllianceBernstein Holding LP. “This is what banks are supposed to do. It should be an economic call decision, not reputational.”

AT1s are the riskiest form of bank debt, as the notes can be written off or converted into equity if a lender’s capital level drops too low. Lenders can also skip coupon payments without triggering a default. These risks for investors are offset by high coupons that have let euro investors post total returns of 3.9 percent on CoCos over the past year, according to Bloomberg Barclays index data. That compares with just 0.5 percent for senior euro bank notes.


Santander’s 6.75% CoCo bond is now yielding … 33.40%.


Is the Spanish banking Armada on fire?


Deutsche Bank’s 6.25% Perpetual CoCo Bond Is Going CoCo Loco!

A friend of mine testified in the US House of Representatives that CoCo (Contingent Convertible) bonds are the savior of the banking industry. Apparently he didn’t know about Deutsche Bank’s precarious position!

Additional Tier 1 contingent convertible bonds, CoCos, are among the riskiest debt because they can be wiped out to create capital for a bank in a financial crisis. While they are sold as perpetual bonds, they are typically callable after five years. Secondary market pricing of the debt is based on the expectation they will be redeemed at the first call date.

One CoCo bond stands out in the CoCo Loco-sphere: Duetsche Bank’s 6.25% bond. Which is signalling a potential wipe out.


This is not surprising given Deutsche’s performance since the global financial crisis when it peaked at $125 per share in May 2017 and is now trading at an abyssmal $8.31 per share.


Deutsche Bank’s 6.25% CoCo bond is going loco!


Dust Their Brooms: Should Lehman Bros Have Been “Surprised” By Their Sudden Illiquidity? (Bear Stearns Then Fannie Mae And Freddie Mac’s Stock Price Already Plunged)

Movies like “Margin Call” and “The Big Short” make the financial crisis look like a total surprise … to them. Well, it wasn’t a surprise to GSEs Fannie Mae and Freddie Mac. Their common stock prices (green line) began plummeting in December 2007. Lehman Bros stock price didn’t start plummeting until February 2008.


Why? National home prices had peaked in 2006 and had slowly begun to retreat. But as of December 2007, the Case-Shiller national home price index had fallen 17.4% from the peak in 2016. Subprime delinquencies had risen 46.5% over the same period. U-3 unemployment started rising in a big way in 2008.

But as home prices nosedived in 2008, subprime delinquencies skyrocketed. You can see Fannie Mae’s large drop in price in November 2008 (while they didn’t purchase subprime loans in high volume, they did invest in subprime ABS and ALT-A loan deals). While ALT-A turned out to suffer big losses, they performed better than subprime after the intial subprime spike.


On September 6, 2008, Fannie Mae and Freddie Mac were placed into conservatorship with their regulator, FHFA and remain there ever since. Also in September, Lehman Bros declared bankruptcy … afer Fannie Mae and Freddie Mac were placed into conservatorship.

*There was other lenders that failed or had to be absorbed elsewhere, like Countrywide, and Wachovia.


But Fannie Mae, Freddie Mac and Lehman Bros demise came AFTER Bear Stearns demise in March 2008, owing to subprime deal failures. In fact, you could see trouble brewing shortly after home prices started to fall. By 2007, both Bear and Lehman were showing distress, but not Fannie Mae. Fannie Mae and Freddie Mac’s regulator, FHFA saw the warning signs with subprime and took action on September 8th (maybe prematurely since they could have continued).


Congress bailed out the banks and Fannie Mae and Freddie Mac and swept the financial dust away (aka, dust their brooms).

Just look at the above chart. Starting in 2016, risk managment at all financial firms should have been on yellow alert. By Q4 2007, it should have been upgraded to red alert. How is it possible that Lehman Bros or Bear Stearns (or Goldman Sachs) were taken by surprise as Margin Call implied.


Oh well.