The AT1 market has proved it has a purpose
Bank debt capital is a hot commodity again across the globe. The AT1 layer, in its current form, has fulfilled its modus operandi
Banking regulations implemented in the wake of the financial crisis of 2008 have been slammed as being too burdensome, ineffective, or even curtailing the business activities of banks.
But capital requirements and the different layers imposed on banks in a bid to isolate the public from having to bail them out once again proved their effectiveness during the most recent crisis. The success of one of the most crucial instruments imposed by the post-GFC capital regulations governing how debt is used to bail in a bank, has shown that it has largely served its purpose.
The demise of Credit Suisse, the first globally systemically important bank to fail after the GFC, demonstrated that the additional tier one (AT1) layer of capital, the most junior debt capital of a bank — or preference shares as they are called in the US — has done what it said on the tin.
It was a test case that has now given real life results.
The market moves before and after the rescue of CS were turbulent — modern bank failures tend to be encircled in volatility given banks' significant standing in an economy — mixed with instabilities and uncertainties.
When the beleaguered Swiss bank was rescued in mid-March and sold into the arms of its cross town rival UBS, some $17bn-equivalent of its AT1 debt was completely written down. That action taken by the Swiss Financial Market Authority (Finma) spooked global markets, hitting subordinated debt particularly hard.
Much debate ensued. Was Finma right to wipe out AT1 bond holders and leave some value for CS’s equity holders, or should the hierarchy have stood. That supposed twist of a bank’s capital structure shocked and irked not only investors but other larger market regulators. But this focus on equity investors recovering value also misses the point of the AT1 layer.
The contentious argument — which is still being legally fought — is not about the viability of the AT1 as a capital buffer in case of a bank failure. It is about whether bank capital hierarchy, or the presumed one at least, was respected.
The Swiss twist faced a response by major global regulators that stepped in to assuage nerves that equity holders will be the first to suffer in a bank failure. But what CS’s holders received in UBS shares was more or less a symbolic Sfr3bn value at the time CS rescue deal was struck.
Had the equity layer been added to AT1s to boost the extra cushion to some odd $20bn-equivalent of capital, it would have smoothed the burden on regulators, public guarantees and, of course, sweeten the takeover for UBS.
But AT1 investors were nevertheless wiped out.
Fear ensued. But it was the fear of the first G-SIB failure since the GFC, the unknowns from depositors’ flights in a newly digitalised world and, of course, a fleeting trust for banks. It was not specifically a fear of the AT1 asset class. These were bank-specific and credit-linked concerns.
It's a credit story
Fast forward to the present, less than a half year after this volatile period, and the bank bond market appears to have recovered almost fully across the capital structure. And globally.
This week BNP Paribas issued the first dollar AT1 from a bank in the developed world since CS’s collapse. The $1.5bn perpetual non-call five year deal attracted peak demand of almost $7bn.
With investors fighting for allocations, the French bank was able to slash the price by 50bp from the initial guidance in the 9% area. That was no mean feat as the deal landed close to the low end of the 8.5%-8.625% fair value estimate.
That kind of a price, backed by robust demand, is an indication of investor confidence in the asset class.
Moreover, this was not even the first AT1 since the demise of CS. In the positively insulated Japanese domestic market, Sumitomo Mitsui Financial Group assuaged local buyers' nerves post-CS demise to sell them ¥140bn ($1.04bn) of AT1 capital as early as mid-April.
Naturally, it took longer for sentiment in Europe to recover. But as soon as the middle of June, not one, but two euro AT1s were issued by BBVA and Bank of Cyprus.
Then a fortnight ago, Wells Fargo raised $1.725bn from a perp non-call five preference share deal that finally pulled in US onshore accounts in that part of the capital structure.
The trade showed that US buyers were also eager to partake in bank capital investments as they provided demand of $6.25bn. Wells’ trade came with a 86.5bp lower yield than that of BNPP.
This price gap and the unfulfilled demand for both deals suggest that more can be issued in dollars from both foreign and Stateside banks.
What is clear is that investors are back in the asset class. BNPP’s deal, as one banker said this week, went the “full circle” for the AT1 bond market as it reopened the deepest bond market, in dollars, to the AT1 asset class.
As GlobalCapital argued in the immediate aftermath of the Swiss bank’s rescue, the AT1 asset class served its purpose, and it served it well. The CS’s AT1 wipe out was a test case which investors recognised and have accepted.
The capital layer may not be perfectly tuned but with the higher yield for the higher risk involved, it shows bank capital regulations are serving a purpose.