US corporate earnings: On par
Two months have now passed since the Swiss regulator’s decision to controversially write down Credit Suisse AT1s and in doing so subordinate them to equity. At the time of the decision market furore was widespread and even extended to the European and UK regulatory bodies strongly condemning their Swiss counterparts. However with the AT1 market still trading heavily in the aftermath, when news agencies reported yesterday that the European Banking Authority (EBA) was looking at reforms to the sector to boost interest, AT1 markets reacted very positively.
The two main possible changes highlighted were a ‘dividend stopper’, whereby dividend payments would be turned off before AT1 coupons, and ‘cumulative coupons’, which would allow banks to pay coupons that were deferred or skipped. We note that these changes would not necessarily have a huge change on bank behaviour with no current benchmark bank having missed a coupon, however it does strengthen the instrument and reiterate the point that AT1s sit above equity in the capital structure.
What the EBA’s report did most importantly, was underline their commitment to the AT1 asset class. The purpose of current discussions was to ‘boost interest’ in the AT1 market; they have invested a lot of time into improving the capital stack of banks - including the AT1 instrument - post the Great Financial Crisis, to make banks more resilient, and are keen to maintain the successful changes made. For AT1s to be part of this going forward, levels need to normalise to incentivise new issues and the resumption of a functioning market.
The European authorities certainly have the power to positively influence the market, for example, a change that has been discussed for years now, is an increase of the CET1 trigger level for AT1s; this would be a huge positive catalyst for the market as it could potentially turn a large chunk of AT1s into quasi-bullet bonds – although we note that this wasn’t mentioned in the reports yesterday. Whatever the conclusion, one thing that does look likely is that the EBA is going to provide a tailwind to the AT1 market in the coming months.
In response to the report, AT1s rallied by 1-3 points yesterday, but bond prices are still down by 8% from recent highs in February, with IG-rated Barclays AT1 currently trading at ~14% in $ to the 2025 call and IG rated BNP AT1 trading at ~12% in $ to the 2027 call. Negative headlines from US regional banks have kept a lid on a potential rebound over recent weeks, however these are perhaps beginning to subside.
A strong set of European bank results, a continuation of AT1 calls due to excess capital (as seen with Unicredit and Lloyds in the last month) and potential signs of a reopening of the AT1 primary market (yesterday saw Royal London issue a Perpetual RT1 bond) should all see positive momentum in the sector. Markets usually need a continuation of bad news to keep yields at or close to historic highs, with the additional tailwind from the EBA, it is difficult to see AT1s staying at these elevated levels for long.