Euro zone banks sell subordinated bonds after three month hiatus

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LONDON (Reuters) – The euro zone issuance market for subordinated, loss-absorbing bank bonds re-opened this week for the first time in almost three months after a severe sell-off in the asset class due to the coronavirus pandemic.

The 80 billion euro ($86 billion) market for these bonds – the riskiest debt banks can issue – had been shut for issuance since Feb. 20, according to Refinitiv IFR data, as borrowing costs shot up, while banks also waited to release their first quarter earnings.

Deutsche Bank (DE:DBKGn) kicked off the issuance earlier in the week, raising 1.25 billion euros of “Tier 2” debt on Monday, followed by Bank of Ireland (I:BIRG), which raised 675 million euros through an “Additional Tier 1” (AT1) bond on Thursday.

Additional Tier 1 bonds – also known as “contingent convertibles” or “CoCo” bonds, are deeply subordinated and convert into equity if a bank’s capital level falls below a certain threshold.

Tier 2 debt is a more senior type of subordinated debt, as it only gets converted into equity when a bank defaults.

A banker involved with one of the week’s deals, who asked not to be identified, said that issuers were more willing to pay higher borrowing costs, realising they could come under further pressure once second quarter earnings demonstrate the full hit they’ve taken from the pandemic.

But a flood of issuance is unlikely to materialize, said ABN AMRO (AS:ABNd) strategist Tom Kinmonth, citing elevated borrowing costs, and more issuers may opt to not redeem their outstanding bonds at call dates. This has stoked debate about the risks in the market, as these securities are often traded on the assumption that banks will redeem them.

“The market focus from the regulators is to not weaken your position… The AT1 market is still at a very elevated level,” Kinmonth said.

He added that banks’ capital ratios have been helped by postponed or scrapped dividend payments and recent regulatory changes, meaning there is less need to borrow at expensive levels.

The European Central Bank’s accelerated change in March in capital requirements allowing banks to make partial use of these bonds to meet their capital requirements could help issuance eventually pick up.

The yield on the iBoxx euro subordinated bank bonds index shot up to 6-1/2 year highs at the height of the sell-off in March. While it has reversed some losses since, the index still yields 2.26% compared to 0.75% prior to the crisis.