Blain's Morning Porridge, submitted by Bill Blain

Its officially: “Take a Pop at Banco Santander Day”!

Yesterday Banco Santander didn’t make an anticipated call an old Euro 1.5 bln Tier 1 Contingent Capital issue. They’ve cited an “obligation to assess the economics and balance the interests of all investors” – which translates as shareholders first. As I’ve said before this week: at Santander you’re either a Botin or a Botone. (As Spanish banking proverb meaning you’re either part of the Botin family or nothing more than a mere servitor like a butler..)

Santander’s call was optional, but not calling it creates potential reputational damage for the bank – according to a slew of press stories this morning. Some say it puts them into a particular Circle of Hell (not the same one as Boris Johnson, Dodgy Davis and Farrage) of bad banks, previously reserved for Deutsche Bank.

I remember that day well.. Back in 2008 Deutsche Bank – then a leading European investment bank, was batting in the big leagues against the Americans, was the place everyone wanted to work for, to be banked by, and to own - decided the deteriorating financial situation meant they would not make the expected call on a Lower Tier 2 capital deal. The market was gob-smacked. They did it again in 2013 – missing a call on a Tier 1 deal, and further peeving investors. Deutsche Bank’s reputation took a massive spanking – I’d argue its current travails and loss of premier status stems from these events.

Back in 2008 I’d warned clients holding the Deutsche deal the call might not be made because of the extraordinary market circumstances, but that was because I was then already very old and remembered what happened during the great perp bond crash of 1986 when investors made the similar mistake of thinking banks were honourable, virtuous and would call their capital issues and not allow them to become perpetual debt. (I believe much of the callable subordinated debt that funded bank capital at Libor plus 25 issued in the mid 1980s are still around (and largely held by Japanese investors.)

Germans don’t do Financial PR particularly well.

The Spanish? Probably less so – but they don’t care. They don’t pretend to want to hug their debt investors. Their DNA is simple: make decisions based on the brutal pragmatic facts and assume the market has no long-term memory. Investors who found themselves holders of the bond, and expected them to call, made a very stupid schoolboy error – assuming Santander would a make a call when it made little economic sense to do so.

Most banks do care about their reputations and would have made the call – if you held Santander and expected it to call, then you didn’t understand the phsycology of the bank you were holding. Your mistake, not theirs.

Santander is not stupid. It proved itself good at acquisitions, and a nimble little dancer when it dodged the ABN/RBS disaster in 2008, by dumping its Italian acquisition while everyone else was looking elsewhere. Now it’s showing pragmatic credentials.

It’s cheaper for Santander to not make the call. The non-called deal currently yields 6.25% but will switch to a lower floating rate around 5.50% after the call expires. That means it’s costing them less than refinancing – the bank did a new $1.5 bln dollar deal at 7.5% last week.

Back when I was a Financial Institutions Group banker I once had the Spanish beat. I’d traipse down to see the Spanish banks to win bond mandates from them – and the conversation basically went: “How much are you (the banker) willing to pay us for the privilege of leading a bond issue for our bank.” The idea banks could actually make money in fees from financing them was heresy. They treat investors with pretty much the same regard – caveat emptor. Which is entirely proper…

Does Santander’s failure to call put another nail in the AT1 CoCo market? You have to remember that CoCos and AT1 have been a stumbling solution to bank capital since the 2008 crisis. Regulators were furious they’d had to step in and bail out banks by injecting equity – debt holders largely weren’t touched. Because the banks didn’t go bust, losses were confined to equity.

So, the regulators they came up with a curious solution that turned the debt subordination ladder on its head. From then on debt investors would take the first losses by being bailed in if the bank faced a capital crisis! That was a truly bizarre moment – it meant debt investors took all the downside in a crisis, but received none of the upside. Yet, investors love them – taking the view higher coupons more than compensate these risks. Its now a $350 bln market.

A few years ago I wrote a note on AT1/CoCo bonds calling them “Demodium spawned bastard offspring of demented regulators and deranged banks”. Whatever, they yield enough to be investible.

Now that Santander has set a precedent, some pundits think all banks will follow suite, and not call their AT1 deals – triggering a likely sell off across the sector. Yet this morning the market is higher – Why? Because investors are being more selective, and looking for bargains in the names they think care more about keeping investors happy. Even Santander’s recent US$ AT1 is higher!