High-risk bonds, known as AT1 Bonds, have gained a bad reputation in recent years. Investors hoping for a quick buck have found that the rules of the game have changed and they may not be able to return their investments as hoped. This situation illustrates the vulnerability of the global financial system given rising borrowing costs and the effects of the war in Ukraine.
What are AT1 bonds?
The acronym AT1 refers to bonds Additional Tier-1These are debt instruments with no maturity date issued by banks with the aim of absorbing losses in emergency situations if capital falls below a certain level.
Specifically, these bonds are based on the Tier 1 security they are named after. This is a soundness index calculated on the basis of the relationship between a credit institution’s capitalization and its investments in assets.
AT1s are also known as contingent convertible bonds, or CoCos more commonly, as they can be used to cover any losses by being called or converted into principal or other equity. In this way, an economic crisis phase that could lead to the failure of a bank and thus an extremely difficult situation for the entire credit industry is avoided.
The Credit Suisse case
The almost complete collapse of CreditSuisse Earlier this year, he prompted the Swiss government to issue a bailout that scrapped billions of dollars in AT1 bonds, stunning investors and driving up costs for other banks looking to sell their bonds. As a result of this situation, some smaller banks have decided to deviate from the bonds’ normal repayment schedule and keep them open beyond the expected five years and continue to pay interest.
These banks include the Raiffeisen Bank International (RBI) that he will again skip the call option on his 6 AT1 bond50 million euros Mid-June. A spokesman for the bank said RBI is committed to calling and refinancing the bond issue as soon as possible, but only if the economy is right for it. This decision follows the example of two other German banks, Deutsche Pfandbriefbank and Aareal Bankwho have opted to leave their €300 million bonds outstanding rather than proceed with repayments.
The repercussions of this bank reversal can also be seen in the market as the cancellation of Credit Suisse’s multi-billion AT1s continues to resonate in the sector. That is estimated at around 275 billion US dollars. Investors, surprised by these decisions, have become more cautious when investing in bonds from medium-sized bank issuers. consequently, Bond yields rose more than 10%an 8% rise ahead of the Credit Suisse bailout as investors seek higher premiums to offset risk.
AT1 bonds are becoming less and less attractive to investors
Alessandro Cameroni, portfolio manager at asset manager Lemanik, said the AT1 bond market is splitting. The big banks, worried about the negative consequences of non-payment, are acting accordingly, but the situation is becoming increasingly difficult for smaller issuers who would actually like to pay back investors.
Peter Harvey, a fund manager at Schroders, pointed out that market stress is separating large, strong banks from weaker institutions. Smaller and more fragile banks will be more inclined to lengthen bond maturities, angering investors. A concrete example of this is RBI, whose non-public repayment announcement has led to investors no longer expecting a repayment by mid-June. The bank said the higher cost of issuing a new bond issue played a role in its decision.
AT1 bonds were designed as a buffer for banks to absorb any losses and to help calculate their capital buffers. However, investor demand for these bonds is waning. According to Invesco ETF, which monitors the market, AT1 bond prices fell to a three-year low during the recent banking turmoil. According to the investment manager Federated HermesAT1 bond prices show that investors expect only a tenth of bonds to be redeemed as expected.
Some big banks, like UniCredit And Lloyd’s, have effectively redeemed their bonds. However, other banks will face significant maturities over the next 12 months. For example, Society Generale must repay $3 billion in debt, UBS extension $2.5 billion and Santander $2.3 billion based on bank statements.
This situation poses a dilemma for banks that need to borrow or refinance. The analysts of MorganStanley We expect that European banks will have to issue more than 400 billion euros of AT1 debt over the next three years. However, the high cost will deter many of them. As he claims Karsten JuniusChief Economist at J. Safra Sarasin, the alternative would be to raise capital, but that would be even more expensive.