Santander's CoCo Bond Creates All Kinds of Trouble

(Bloomberg Opinion) -- How to lose friends and alienate investors. Spain’s biggest bank, Banco Santander SA, chose to wait until the last available moment to tell holders that it wasn’t going to redeem a particular 1.5 billion euro ($1.7 billion) bond after all.

The note in question was a so-called Additional Tier 1 (an AT1 or CoCo for short) and it’s accepted practice in the market to call these bonds on their redemption date. Santander’s decision may make sense for the lender from a purely economic perspective (it’s cheaper right now just to keep the AT1 running rather than issue a replacement), but it’s an incredibly cavalier way to treat investors. Even holders of Santander’s equity, who ostensibly stand to benefit from anything that saves money for the bank, took a dim view by pushing its share price down on Wednesday morning.

Bondholders accept that AT1s carry greater risks than typical debt in exchange for a higher coupon, 6.25 percent in this case. They can be written down and converted into shares if a bank’s capital ratio falls below a certain level. But, perhaps innocently, many European investors assumed they would be always called at the end of their term. Not any more.

The value of the CoCo has dropped sharply since holders started to fret about Santander’s intentions (although not as much as you might expect). Nevertheless, the biggest loser might end being the bank itself. The doubt it has left in traders’ minds may force up the yield it needs to offer to sell debt in the future. 

Santander's CoCo Bond Creates All Kinds of Trouble

A non-call is a first in Europe for an AT1 and, while Santander was within its rights to do what it did, it has been unnecessarily brusque in keeping investors in the dark. Bond market hopes rose last week after the bank issued a separate dollar-denominated ($1.2 billion) AT1. Some European investors thought they’d be rewarded for supporting this not-very-attractively priced issue with a redemption of the euro CoCo. Those hopes were misplaced.

Again, Santander didn’t do its investors any favors with its non-communication around the dollar AT1. It could have simply dispelled some of the muddled thinking in the market rather than offering up total silence. Surely it’s better to talk openly with your bondholders and the wider investing public who might be stakeholders in the future. It’s simple business commonsense – and good manners.

Still, looking at this purely economically, the cold reality is if Santander had been upfront with investors last week, it would almost certainly have paid much more than it did for the dollar AT1, which is trading 35 basis points wider than at launch. It’s questionable whether it would even have managed to have sold a new AT1 having not called an existing deal. This is why both dollar and euro investors in Santander’s perpetual debt are unhappy.

So the bank might well have burnished its own reputation for ruthlessness by keeping its funding costs as low as possible, but at what cost? 

Of course, bond traders aren’t exactly babes in the wood. Almost all of the holders of the euro AT1 will be institutions, and Santander won’t have wanted to be pushed around. But this security is eligible for retail investors too. It begs the question whether Europe’s regulators should follow the U.K. in preventing such high-risk instruments being sold to private clients. 

Santander’s actions certainly don’t help the wider euro AT1 market. Other lenders with call dates coming up will be under pressure to communicate their decision processes better, which may be a positive development. But Santander’s move will further separate the stronger banks from the weak. The latter will still have no choice other than to redeem at the first call date otherwise they’ll never attract investors. AT1 spreads will no doubt widen – for a while at least.

So, bad for investors, bad for Santander and bad for smaller banks. Was it really worth it for a small financial gain?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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