Santander’s dramatic withdrawal of an offer to hire Andrea Orcel as its chief executive may have seized the headlines in recent weeks, but the Spanish lender’s decision to not honour a “gentleman’s agreement” in the bank bond market could prove more consequential.
Late on Tuesday, Santander announced that it had decided against early repayment of a €1.5bn capital bond, defying the expectations of many analysts who had argued just a week earlier that such an outcome was a near certainty.
But while Mr Orcel is preparing to mount legal action against Santander over the bank’s rescinded offer, aggrieved bondholders who saw the value of their debt fall sharply have no such recourse: the bank had absolutely no obligation to repay — or “call” — the bond at this time.
While the furore may perplex outside observers, it was a watershed in the $200bn market for “additional tier 1” (AT1) or “coco” bonds, the riskiest type of bank debt that can be written off in times of stress.
The European market has long relied on an understanding that banks will repay their bonds at the first opportunity. A rare decision by Deutsche Bank not to call such a bond a decade ago sent tremors through the market at the height of the financial crisis.
However, European regulators do not want banks to honour this gentleman’s agreement if it would increase the bank’s interest bill. This is because policymakers designed coco bonds after the financial crisis to bolster banks’ balance sheets, making them more resilient, not less.
One senior debt market banker said that the treasury departments of several other banks were running sweepstakes on whether Santander would call the bond or not, reflecting just how much debate there was in the days leading up to the decision.
This uncertainty did not even exist just a fortnight ago. Then, few people in the market were suggesting that such a call was even a possibility. Santander’s management reiterated on a late January investor call that they would only make a repayment if it made economic sense.
But then Santander completed an unusual deal last Wednesday, which prompted many investors to change their prediction. The Spanish bank launched a new $1.2bn AT1 bond sale, which seemed designed to fund a looming repayment of the existing bond.
The impression that a repayment was imminent, was strengthened by the deal’s unusual timing and structure. Santander issued the bond during the Chinese new year holidays, meaning that important buyers such as Asian private banks would be out of action. To some, that suggested that the bank was in a hurry to fund the call.
The rush proved costly for the banks managing the sale as they were not able to fully sell the $1.2bn deal to investors, so had to take some of the bonds on to their own balance sheets. A person familiar with the matter said underwriters were only left holding a “very small amount”, however.
The bond also had an unusually short settlement date of two days, meaning that Santander would have the money in its hands last Friday — which investors believed was the bank’s deadline for calling the coco. This is because a notice had to be filed 30 days before March 12, which fell on a Sunday.
But the bank then told investors that they actually had until Tuesday February 12 to make a decision. This is because the bank had legal advice that 30 days should be interpreted as a month, disregarding that there are 28 days in February.
For some in the market, this was the first sign that something was not right. Others became more adamant that a repayment would happen, arguing that the bank was just looking for a little more time to go through the final steps.
Santander’s decision not to call left those former optimists asking one key question: why did the bank raise the new bond in the first place?
Credit analysts at JPMorgan argued after the decision that the $1.2bn new bond was still most likely issued to replace the €1.5bn existing bond. The analysts described the decision not to call as a “technical glitch” surrounding regulatory approvals. The analysts argue that the bond should now be called in three months for that reason.
Vicki Cockbain, a director at Aberdeen Standard Investments, says she was “sanguine” about the incident given that Santander can revisit the decision in three months.
“The worry would be whether other banks would start looking at call decisions differently,” she said. “But I would be surprised if that would happen just because Santander treated their call as they always said they would — on an economic basis.”
The overall coco market took Santander’s decision in its stride, with the average price of such bonds actually closing the day higher on Tuesday, despite a big drop in Santander’s bond.
“The market moves dramatically when everyone expects ‘white’ and then ‘black’ happens — that wasn’t the case here,” says Jérôme Legras, head of research at Axiom Alternative Investments.
“People may be pissed off, just as they’re pissed off when their football team loses, but everyone knew it was a ‘balanced probability’ event and it just fell on one side of the coin,” he says.
