Don't scoff at talk of AT1s repricing HY

Chinese bank capital bonds are the main talking point for anyone involved in Asia’s debt capital markets at the moment. And rightly so: the amount the country's big five banks plan to raise is huge.

Bank of China (BoC) is to be the first one out of the gates and will start marketing its $6.5bn AT1 on October 9. The other four — Agricultural Bank of China, Bank of Communications (BoCom), China Construction Bank and Industrial & Commercial Bank of China — are also setting their sights on similar amounts.

At an estimated combined size of up $25bn, the deluge of supply could have huge repercussions on the market, especially on the high yield sector. That’s because AT1 bonds are expected to offer similar, if not better, yields to BB-rated names.

Bankers have been downplaying the impact of Chinese bank capital on the high yield sector, however. Their reasoning is that AT1 and high yield are entirely different types of risk and so investors would be daft to swap one for the other. Land banks are not much like financial banks, after all.

But it turns out investors may not be so discerning, especially when they sense a bargain is in the air.

Morgan Stanley posted the results of a survey this week that showed of the 148 investors they interviewed, almost 40% said they would switch out of Chinese high yield corporates into China bank AT1s if the yields were similar.

And unfortunately for the defenders of the high yield market, AT1 yields look set to be attractive. Bank of China, for example, is said to be marketing its AT1s at 6.5%-7.0%.

The defectors’ case for making that switch is clear: they will be effectively buying into blue chip names at a high yield price. Even tastier is the fact that they view default risk at the big five as close to nil, given the banks’ systemic importance to China’s economy.

A cheap investment with no potential downside is a good bet, whatever way you look at it.

Then there is the other 60% of respondents who either said they would not switch out of Chinese high yield or that any decision to do so would be independent of the AT1s.

Well, the decision to buy AT1s is certainly likely to be independent of their wishes if the product is included in indices such as the JP Morgan Asia Credit Index (JACI). Most funds track the JACI and considering the size of the trades, it is surely only a matter of time, and paperwork, before the AT1s are included.

Investors don’t have to buy into the deals at launch, however — they can just as easily wait until AT1s are included in the JACI and then pick them up in the secondary market, but either way a portfolio adjustment is inevitable.

Of course, investors do have a choice over whether to adjust their high yield portfolio or something else in order to free up cash for AT1s. But from a rating and yield point of view, AT1s fit nicely into that bracket. 

With the outstanding Asia ex Japan corporate high yield sector estimated to be worth around $110bn-$120bn, any adjustment is going to leave its mark. It might not be sensible but for many investors it makes perfect sense.