Context: HSBC has announced additional cuts in response to the impact of the COVID-19.
Retain earnings and capital preservation policies could force the bank to not call the outstanding AT1 Cocos at the next call date, as already announced from Lloyds
Impact for the fund: Positive, from a bondholders’ perspective the capital positions remains strong and the extension risk arising from the non-call is already priced in as the majority of the AT1 cocos are already trading at maturity.
Considering the time being, an issuer not calling a AT1 coco is not much of a surprise as it would technically translate in refinancing an existing bond at a worst condition than when it was originally issued and would go against the policy imposed by the regulator to retain capital and increase capital buffers, despite this as shown by the bond of Lloyds the risk of extension is fundamentally already priced in, so we should not expect big changes in the prices of the underlying in case of bonds not being further called
Looking at HSBC, for example taking the 5.25% AT1 Coco in EUR
YTC increased from 1.1% to currently 5.03% in the event that HSBC will call this bond in 2022.
In the event of a non call, this bond to maturity (perpetuity) gives a yield of 4.4% which for a IG rated bond looks very attractive, especially considering that this bond has still 10% of capital gains upside potential vs fair value
To sum up, as bonds currently price in significant extension risk in and considering current valuations, even pricing the securities to maturity offers a very attractive opportunity to capture high coupons and therefore limited risk of large price drops in case of non-call.
Level of coco priced to perp is currently 86%