If investors are comfortable buying a bank’s tier two debt at a slightly higher rating, then why not look at the lower rated additional tier one (AT1) too?
While the lower ranked and rated debt may be riskier, the underlying bank credit is still the same. Once you strip away all the features surrounding subordinated debt, you are left with exposure to the same issuer with the same quirks.
When buying a bond, investors are in effect making a bet on whether the borrower can meet its obligations and repay the principal — plus interest. Investors in Abanca’s latest subordinated outings, in which the bankissued tier two and an AT1, will hope that both trades are called and refinanced in roughly five years’ time.
Of course, AT1 debt is riskier — hence its lower rating — and the chance that the paper is extended is far higher. But if the debt hierarchy is to be believed, then AT1 investors will be the first bondholders against the wall following a write-down event. Tier two holders should, in theory, be next.
However, buyers are rewarded for taking on this risk. Abanca’s AT1, for instance, was priced at a yield of 10.625%, 225bp wider than its recent tier two.
Ultimately, if a bank collapses, then subordinated debt investors are probably all in the same boat — unless it's in Switzerland of course.
Deeply subordinated paper is not for everyone, and not every investor with a mandate for tier two debt can buy AT1 paper. But if you're confident a bank will repay its subordinated debt when it comes up for call, then why not also consider the tier two’s more junior — yet juicier — AT1 sibling.