The European Banking Authority (EBA) is holding talks this month to discuss ways to boost investor interest in the additional tier 1 (AT1) market following the collapse of Credit Suisse, which resulted in Swiss authorities wiping out $17bn in AT1 bonds.1
With this in mind, the team have highlighted seven key reasons why it is essential to re-establish trust and investor interest in the asset class.
Figure 1: AT1 year-to-date Z-spread evolution, by currency
Source: Credit Suisse Index Plus, as at May 2023.
AT1s should trade inside the generic 10% cost of equity for the listed European (and UK) banks. More broadly, the asset class plays a significant role for the following key reasons:
- Size: The AT1 market is important for banks’ capital reserves, with over $245bn in the sector. A functioning AT1 market therefore plays a significant role in the pricing of other (much larger) bank liabilities, such as senior bonds.
- Unintended consequences: Without AT1s, banks would have to hold more common equity (CET1), restricting their lending capacity, which would be particularly detrimental for bank-centric Europe by lowering their prospective return on equity (ROE).
- Regulatory support: Regulators have stood behind the asset class in difficult periods before, such as the oil price slump of Jan 2015, the Covid-19 pandemic in March 2020, and during the first quarter of 2023 after the Credit Suisse event. If the regulators want to revive the asset class following the collapse, then it requires more security and fixed income-like attributes.
- Rates: We are at, or close to, peak rates. This should support depressed cash prices.
- Supply: Supply has been non-existent since the Credit Suisse demise. Banks are therefore running excess CET1 ratios and the majority of 2023 calls have been pre-financed.
- Fundamentals: Fundamentals have been strong in the first quarter, highlighting the benefits of normalised rates (higher net interest income), high capital, stable funding, and a solid asset-quality outlook. They have also seen markedly enhanced disclosures, such as deposits, CRE, and so on.
- Pricing: Only about 10% of the market is trading to first call. From a historical standpoint, we believe this is too harsh as the market will eventually differentiate between issuers.