I. AT1s: the show must go on
a) AT1 remains an important part of a bank’s capital structure
The shock of the CS AT1 wipe-out was significant, but ultimately did not change the rationale of the AT1 market, both for investors, issuers and supervisors:
▪ For issuers, AT1s are a cheap source of regulatory capital, if only because of tax deductibility.
▪ For investors, the loss rate over the past ten years remains low (70bps) compared to a credit spread which is significantly above the spreads of corporate issuers with similar ratings. The 10- year historical return (in EUR) of the Markit Coco index has been 56% vs. 27% for the ICE BOFA BB non financials index.
▪ From the point of view of supervisors, AT1 bonds performed their “duty”, providing capital in a going concern situation, even if regulators worldwide were keen to distance themselves from the Swiss approach which blatantly inverted the hierarchy of losses: “Additional Tier 1 is and will remain an important component of the capital structure of European banks”.
For now, the primary market has not reopened, but, as in similar recent episodes of market stasis (Covid, Ukraine) we expect it to reopen soon, not necessarily with the strongest issuers (Bank of Ireland reopened the market after Covid.)
You can find more details in our analysis below.
After a difficult Q1 2023, the debt market for financial institutions recovered in Q2, fueled by a strong earnings season and a reopening of the primary market, including for some small and infrequent issuers. Some calls and liability management exercise, especially linked to the Libor transition, also supported prices.
The reopening of the AT1 primary market by BBVA should support the repricing of the asset class as the fall of Credit Suisse had cast a shadow over the primary market for several months leaving investors wondering if an issuer would be brave enough to come to the market.
Some market rumors about possible regulatory changes and upcoming calls justify measured optimism. The remaining question mark, as always, will be the macro environment, as investors are left like Godot, waiting for the recession that never comes and possible Commercial Real Estate losses.