“If everybody minded their own business, the world would go around a great deal faster than it does.” The Duchess, Alice in Wonderland by Lewis Carroll

I have been watching with amusement the recent swell of opinion from various market participants regarding Banco Santander and its upcoming first call date of the 03/19 CoCo bonds. These went from a definitive ‘no call’ just six weeks ago to ‘99.9% call’ ten days ago to being ‘outraged/shocked’ on the non-call event. Ominous statements such as ‘special place in hell for Santander’ and ‘severe implications for the AT1 market’ from otherwise reputable financial commentators followed.

Fast forward to today, Santander did not call the 03/19 CoCos, they did not drop 10 points, and the floor under the rest of the AT1 market did not disappear. And rightly so. Let me remind you that one of the defining characteristics of the CoCos is the lack of incentive to redeem (by, amongst other things, eliminating the ‘step up’ in spread that issuers have to pay after the first call date has passed). This removes the pressure on issuers to replace bonds at uneconomical terms. Back to Econ 101, this is in all investors’ best interest long term too. It is very simple to understand, yet I continue to be amazed by the number of people who fail to grasp it.

A quick cross-Atlantic parallel reveals a pretty similar, perfectly functioning bond market that has long operated on economic call premises (and continues to do so) but without the drama. Logically, there is absolutely no reason why it should be any different in Europe. If anything, today’s decision by Santander to skip the call (and I will ignore for now the theories regarding the technical nature of the non-call) is merely a sign of a maturing market, which arguably € AT1 has become.

Reputational damage arguments should have long given way to rational investment decisions. How much of a premium did Deutsche Bank have to pay when reputation WAS the main call driver? Why would it be any different now that economic call policy is the new ‘old’ norm? Banco Santander (and Credit Agricole for that matter) have been very vocal that it would be primarily an economic decision. This, combined with the particular structure of the bonds in question, as well as the current size of Santander’s AT1 bucket, ought to have left very little to the imagination regarding the call for anyone sporting a decent size calculator.

Thus I struggle to understand any investment decision built solely around the ‘reputational damage’ case. If you were surprised by the decision not to call, there is probably a better future awaiting you in a different occupation. If your investment case was solely based on ‘reputational call’, you are doing it wrong. If you don’t understand why it is better to replace debt with cheaper debt, not more expensive debt, you should go back to basics.

We at Kames aim to capture alpha by building investment cases around strong business fundamentals, attractive valuations, and compelling risk/reward, not around reputation. That said, the now busted call Santander 6.25% 19c may prove to have been a fairly interesting proposition down the line.

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