By Anna Hirtenstein
Investors are betting Spanish lender Banco Santander SA won't be
able to make interest payments on a risky form of bank debt. In a
strange twist of events, instead of shunning the debt, investors
are scooping it up.
It isn't that the bank can't afford to pay the interest. It is
that the securities don't allow Santander to pay the coupon if it
doesn't turn a profit this year, which it isn't expected to do.
Investors are speculating that Santander will save its reputation
by redeeming the securities instead of missing the coupon
That bet sent the price of the securities surging 18% on Oct. 7.
It closed at 91.21 cents on the euro that day, up from 77.36 cents
a day earlier. On Monday, it was still trading at 91.99 cents.
"This is one of the weirdest things I've ever seen in markets:
it is one for the history books," said Jerôme Legras, managing
partner of Axiom Alternative Investments, which has a focus on bank
capital. "Usually, a bond price will fall if a bank is perceived to
have issues with paying. But in this case, it rose."
What triggered the bet was a note from Fitch Ratings on
Wednesday forecasting that the Spanish lender won't be able to make
the coupon payments. Fitch cut the ratings on the securities to
CCC, one of its lowest tiers, suggesting that a default is
The securities don't currently pay a coupon. They offer a
floating rate: The coupon is reset every six months and pays 0.05
percentage points over the 10-year euro swap rate that the debt is
linked to. Many of these benchmark rates have in recent years gone
subzero due to the European Central Bank's quantitative-easing
programs. The coupon on Santander's bond is currently minus 0.18%,
which effectively means the bank doesn't have to pay anything to
Even if that rate goes positive, Santander doesn't have to pay
the coupon until it posts an annual profit again. And the bank
could simply opt not to redeem the securities when it does owe a
payment, which would likely send the securities' price back
Santander declined to comment.
This risky bet by investors shows how complex financial
engineering can create unforeseen consequences for banks and their
"There are still a number of old bonds which were issued at a
time when nobody was even contemplating negative base rates," said
Charles Poole-Warren, a capital-markets partner at law firm Allen
& Overy. "But this could change in the future if it rises above
A range of rates have turned negative across Europe after
central banks flooded financial markets with cheap money. That has
sharply subdued the yields on the safest types of debt, including
government bonds and investment-grade corporate debt. Investors are
getting increasingly pushed into risky corners of the market in
search of better returns.
In this case, investors know the risks they are taking. In
February 2019 Santander took markets by surprise when it said it
wouldn't redeem EUR1.5 billion, equivalent to $1.33 billion, of its
so-called additional tier 1 bond, or AT1 debt. Until then, issuers
had always redeemed the securities -- typically by their first
so-called call date -- as a courtesy to investors seeking the
option to sell some of the debt.
AT1 debt is considered particularly high risk because it has a
perpetual maturity, leaving issuers free not to ever repay
bondholders. The Santander debt that investors are betting on now
also has perpetual maturity.
The bank raised EUR300 million in 2004 from the sale of the
debt. The spread, or extra yield over the benchmark swap rate that
the securities offered to investors tightened to 0.283 percentage
points on Wednesday.
The debt's preferred status means that holders have special
rights: Unless their coupons are paid, Santander can't pay
dividends. The ECB has also asked commercial lenders in the
eurozone to freeze dividends and share buybacks to conserve cash
during the pandemic.
In July, Santander's Chairman Ana Botin said Santander is
committed to paying a dividend as soon as market conditions
The prospectus for the bond offering states that the bank can't
pay a coupon to holders unless it has sufficient "distributable
profits," meaning that it has to book a net profit for the fiscal
Santander reported a second-quarter loss of EUR11.3 billion. Its
third-quarter results, due to be released on Oct. 27, will be
closely scrutinized by bondholders.
The bank won't generate sufficient profit in the second half of
the year to offset this loss, Cristina Torrella Fajas, an analyst
at Fitch, wrote in the Oct. 7 report. That would make it
Santander's first annual net loss in its 163-year history.
"Calling the bond seems to be the only solution at the moment,"
said Artaud Caloni, a credit portfolio manager at Meeschaert Asset
Management, which holds this bond. Santander could also be back in
the black by the end of the year, "meaning the bonds would be
performing again. This would also be a solution, but it's not
likely at the moment."
Write to Anna Hirtenstein at firstname.lastname@example.org
(END) Dow Jones Newswires
October 12, 2020 08:05 ET (12:05 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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