The AT1 is dead, long live the AT1
Higher rates are powering an equilibrium in the AT1 market that may tempt even the most unlikely of issuers to come to the market
The power of interest rates has trumped nearly everything so far this year. Not all of the effects have been positive, but the almighty rates and, arguably, well-crafted bank regulations following the Global Financial Crisis serves to prove that there is life in the additional tier one (AT1) asset class yet, even for Swiss banks that are still sulking from the shock of Credit Suisse’s demise.
The rescue of Credit Suisse in March, mildly put, sent a shockwave through financial markets with the collapse of the first globally systematically important bank since the GFC. At the epicentre, the Swiss banking system, long percieved as unbreakable, was the worst hit
The other shock was in the AT1 market — the deepest and most subordinated bank capital, a layer created after the GFC to give banks a regulatory capital buffer in case they come into serious trouble. It was the Swiss Financial Market Supervisory Authority (Finma) that stoked this fire when it changed the bank capital structure following the initial collapse, sending investors into disarray.
Aiming to rescue the ailing bank and keep the local financial system from imploding, it chose to write down in full the $17bn-equivalent of Credit Suisse’s AT1s. But at the same time, it left some value for Credit Suisse shareholders, who received UBS equity. This was so unprecedented that regulators in other jurisdictions around the world rushed to assuage nerves of strained market participants that bank equity will remain first in the firing line before dismantling the AT1 stack.
Some market participants were so badly stung by the shock and the ensuing legal case against Finma that one based in Swizterland told GlobalCapital "I don't think we will ever see a Swiss AT1 ever again".
But that hardly holds water, from several angles. Not least because of the regulatory need for banks to have that layer of capital cushioning in case of a resolution. As GlobalCapital has argued before in this section, the AT1 market has a purpose and it has served it this year, despite the fracas.
The anger, shock and dismay from Finma's decision was mainly because that small fraction of CS equity was left untouched, while supposedly higher standing capital was annulled. This despite the fact these very same equity investors had bled for years as CS's value decreased, with the bank embroiled in scandal after scandal.
And UBS, as the only global bank remaining in the country, is sure to make use of the AT1 market to fill up the shortfall left after the $17bn AT1 wipeout at CS. Otherwise it will have to significantly reduce its risk taking, which could make it starkly unncompetitive compared to global peers. Either that or be forced to issue more expensive and dillutive equity. Neither of these options is particularly appealing.
However, with most major central banks seemingly reassuring investors that they are done raising interest rates, the ball is back in the playing field of banks looking to raise debt capital.
The market appears to have mostly believed that perception, and rates have consequently fallen as a result. The 10-year US Treasury yield ended Tuesday below 4.57%, a huge drop considering it nearly hit 5% on October 19.
Rates volatility is not conducive for bond issuance, but it also not for a more sensitive product bearing equity-like characteristics. Now that the volatility has mostly subsided, as it has over the last week, the focus is back on yields and spreads. Higher rates mean higher funding cost for banks, yet a yield of 10% for these bonds is not something investors can lightly ignore as demand for Societe Generale's long-anticipated deal indicated on Tuesday.
At the same time, major European banks are in a healthy state as their third quarter earnings indicated. Sure, problems abound, but with their current high capitalisation levels, issuing sporadic AT1s is not the problem. Moreover, economic woes would likely imply lower loan provisioning from banks, as recent bank lending surveys by the European Central Bank and the Federal Reserve already show.
This suggests lesser need for capital and that most banks will merely refinance their existing AT1 stacks.
Still, the higher rates over the past 18 months have also repriced the AT1 asset class.
These deals offer a compensating yield for the risk when compared to many dividend ratios of bank shares.
Moreover, as these higher rates on the asset class have enticed investors, as witnessed in September, the central bank assurances have put a lid on the rising rates — at least for now — creating something of an equilibrium. As long as this situation holds, or even improves, it is not unreasonable to expect more issuance during the rest of this and into early next year.
Therefore, it is not surprising that market participants are chatting and discussing about the return of UBS in the AT1 market. Indeed, some have even suggested that this could come as soon as Wednesday, as reported by GlobalCapital.