As additional tier one (AT1) bonds become more of a mainstream instrument, their investor base is shifting as those that have supported the market until now shy away from the format, to be replaced by credit and high yield funds.
Of course, this move is great for borrowers. The new accounts offer plenty of granularity and diversity in the belly of the book.
However, these new investors should be wary of why the specialists who have looked at AT1s under the microscope for more than a decade are now spurning them.
The worry expressed by the subordinated specialists is that while yields creep downwards, so do the spreads to which the instruments will reset if they are not called at the expected dates.
For instance, La Banque Postale’s record breaking €750m 3% AT1, sold last Wednesday, will reset to a spread of 312.1bp over five year mid-swaps if it is not called between November 2028 and May 2029.
In comparison, the borrower’s debut AT1, issued in November 2019, will reset to 401bp if it is not called November 2026.
With AT1 instruments there is always the chance that a note will be extended beyond its first call date, opening the possibility of a low reset bond paying a small spread for perpetuity.
For incumbent investors, the question is: Why take on this extension risk when you can hold your position in existing instruments without the fear of giving up spread?
Some specialists are concerned that in the event the market sours, these low reset bonds will get hammered as investors flock out of them en masse.
There was a sign of the soundness of this logic this week, when AT1s sold off in the wake of rates sensitivity.
The cash price on La Banque Postale’s recent AT1, for example, was down 1.69 from reoffer, just under a week after it was issued.
Of course, despite these concerns, the instrument does address the mandate for many high yield accounts. When senior debt is flirting with zero, the prospect of a headline 3% record low yield is tantalising for many.
However, when this class of capital was engineered in the wake of the 2008 Financial Crisis, the intention was not to give investors a new juicy product to buy, but rather to add a layer of insulation to banks' capital stacks.
As such, AT1 brings with it a degree of complexity that new accounts would do well not to underestimate.