© Reuters. FILE PHOTO: The logo of Swiss bank UBS is seen in Zurich, Switzerland on March 29, 2023. REUTERS/Dennis Balibus/File Photo
Written by Chiara Ellisi
LONDON (Reuters) – UBS may have to lure investors with much higher returns when it next sells additional Tier 1 bonds, paying what analysts say could be a punitive price for a Swiss decision to wipe out Credit Suisse AT1s as part of their precipitous merger.
To sell new AT1s, UBS would have to offer a yield in the region of 12%, which would be prohibitive, the analysts said, noting that factors such as broader market conditions and integration progress could lower the cost of future financings.
UBS’s AT1 dollar price, which could be first paid in 2027, fell to 68 cents on March 20, the day after consolidation into the AT1 market, from 88 before that and has since recovered to 78 cents. Its yield is trading around 12% after jumping to more than 16% in March from around 8% earlier that month.
Return on UBS $AT1, https://www.reuters.com/graphics/UBS-BONDS/AT1/egvbyegnopq/chart.png
The risk that integrating Credit Suisse would take longer than expected, become costly, and a potential downgrade were other reasons UBS paid a higher premium than it once did as one of Europe’s largest AT1 issuers.
UBS declined to comment.
AT1 bonds, which were introduced after the 2008 financial crisis, act as a shock absorber if a bank’s capital levels fall below a certain threshold where it can be converted into equity.
The sale of UBS AT1 bonds will test sentiment after a merger that makes it the only Swiss bank and global one, a risky bet that makes the Swiss economy more dependent on a single lender.
“If UBS comes to market today, it will have to pay off compared to the past,” said Simon Adamson, head of global financial research at CreditSights.
There is some sign that the broader $275 billion AT1 market is recovering.
AT1 Bank Capital as a Percentage of Risk Weighted Assets, https://www.reuters.com/graphics/UBS-BONDS/AT1/zdvxdggrqvx/chart.png
Last month, Japan’s Sumitomo Mitsui Financial Group (NYSE:) was the first major global bank to sell AT1s since the March rout.
Over time, analysts expect UBS to sell off a lot of AT1s to meet capital requirements. It had a S$700 million ($755 million) AT1 bond repayable in November followed by a higher note of $2.5 billion in January.
Under unwritten market practice, banks pay off AT1 notes – which are perpetual – at the earliest opportunity and then reissue them.
But investors feared that the banks would decide not to do so because the lack of liquidity and high yields would make it difficult to sell the new bonds afterwards.
British company Lloyds (LON:) plans to recall the upcoming AT1s. Italy’s UniCredit also said it would replace the AT1s but added that it had no plans to sell similar bonds soon.
“At the moment, pricing for AT1 is not attractive so we expect issuance to be low while yields are very high,” said Mark Holman, managing partner at TwentyFour Asset Management.
“In addition, there is and will continue to be a Swiss premium on returns while investors try to absorb the risks that (Swiss regulator) FINMA has transferred to the market,” he said.
Ranking game
Investor appetite for UBS AT1 could also hinge on its credit profile.
Jefferies analysts said the combined bank, which will have more than $5 trillion in total assets invested, was attractive from a three-year perspective but posed significant risks over a 12-month period.
The Adamson rating added by CreditSights for the two banks would have to be equalized and UBS’s rating could be downgraded as a result.
UBS was rated A- by S&P, while Credit Suisse was downgraded in November to one notch above junk status.
“Whatever you look at it, it would reduce the creditworthiness of the acquiring bank,” Adamson said.
For others, clarity once the consolidation is complete and time will help.
“There will be some bumps along the way, but in five to six months probably no one will be concerned specifically about the AT1 market and there will be an appetite for UBS’s AT1s,” said Elizabeth Rodman, president of Global Financial Institutions. In the DBRS Morningstar.