Chart of the Week
Market volatility in the banking sector has been high in recent weeks, notably for Additional Tier 1 hybrid debt, also known as AT1 or contingent convertible (CoCo) bonds. Since 2013, European banks have been issuing AT1 bonds for regulatory reasons and these securities are the most junior form of debt that banks can issue. The decision to write-off Credit Suisse’s AT1 bonds on 19 March deeply unsettled Europe’s AT1 market.
Against this backdrop, March saw the risk premium on AT1 bonds jump from 500 bps (5.00% at call) on 6 March to over 750 bps (7.5% at perpetuity) on 20 March. While spreads have eased since that peak, they remain volatile. Worth noting is that these spreads are now effectively perpetual spreads rather than call spreads.
While spreads widened to a lesser extent than in March 2020 when Covid-19 wreaked havoc markets, the level reached on 20 March 2023 sits near all-time highs. Only ten occurrences of higher spreads have been recorded since the AT1 market was created (0.5% of all trading days). At the end of March 2023, only 6.4% of the sessions since 2013 have had a higher spread.
With the immediate and very negative impact on AT1 valuations behind us, the higher spreads are now translating into higher yields for the segment. Yields to call (the call date is a security’s first possible redemption date) stand at 10–11% while perpetual yields stand at 8.0–9.5%. We believe that these yields provide a buffer large enough to absorb, from a medium- to long-term perspective, the high risk that comes with this market segment.
The opinion expressed above is dated April 7, 2023 and is subject to change.
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