Back in business: the evolving AT1 market

February 2025  |  FEATURE | BANKING & FINANCE

Financier Worldwide Magazine

February 2025 Issue

Thrust into the limelight as a result of the collapse of Credit Suisse in March 2023, Additional Tier 1 (AT1) capital instruments have remained popular despite their association with the Swiss banking giant.

Primarily issued by European financial institutions (FIs), AT1s are theoretically perpetual, but they have call dates at which they can be redeemed.

These securities can be written off as a priority in the event of a crisis for the issuer. Some AT1s include specific clauses that allow them to be converted into shares of the issuer in case of a bank’s crisis, rather than being written off. These are known as ‘contingent convertibles’ or ‘CoCos’. While all CoCos are AT1s, not all AT1s are CoCos.

AT1s can help bolster a bank’s balance sheet if unfavourable conditions arise. They were created in the aftermath of the 2007-08 global financial crisis to assist undercapitalised banks and to mitigate the need for taxpayer-funded bailouts. This enables the issuing FI to absorb a capital loss.

Since then, the popularity of AT1s has been undeniable. In Europe, in September 2024, banks issued around $12bn in AT1 deals, pushing the year’s total to $40bn. And despite concerns about AT1s following Credit Suisse’s write-off, investor interest has remained strong, with oversubscribed issuances and favourable pricing conditions.

“AT1 issuance in 2024 is at a more elevated pace versus the €20bn to €30bn issued per year during each of the last four years,” says François Lavier, head of financial debt strategies at Lazard Asset Management. “AT1 issuance in 2024 had more to do with refinancing than increasing the size of the AT1 buffer by European banks, as most already have an efficient layer of AT1 stack. It is also notable that 99 percent of AT1s with call dates in 2024 were already called or refinanced.”

Driving factors

While the collapse of Credit Suisse was a blow to AT1s, banks, investors and regulators generally remain onboard with the instrument. There has also been a number of factors that have helped to drive the segment, as outlined below by Pradeepa Kuppusubramanian, head of credit research at Acuity Knowledge Partners.

First is an increase in liability management exercises, with most new issuances being coupled with tenders for bonds due for calls as much as 12 months later (around 25 percent of FY25 AT1s have been refinanced).

Second is that US dollars issuance is preferred over euros, with banks paying 25 to 35 basis points lower when issuing in US dollars compared to issuing in euros. However, this can change in the future, influenced by economic outlooks.

Third is longer-dated calls, such as the perpetual non-call 10-year bonds, which have been more evident than before, as issuers took advantage of investor demand for duration.

“Soaring investor demand for yield and duration amid anticipated rate cuts sparked a flurry of bank debt issuance,” adds Ms Kuppusubramanian. “Cash-rich investors have been piling into the AT1 space, offering higher yields in a lowering rates scenario.”

In the view of Mr Lavier, the resurgence of investor interest in the AT1 space is derived from elevated yields and spreads in comparison with other fixed income segments, as well as the high profitability of European banks – factors indicating the health and credit strength of the sector.

Overcoming Credit Suisse

While the write-down of Credit Suisse AT1s was substantial – 16 billion Swiss francs of AT1 bonds – the impact on the segment was only temporary, with the investors that left quickly being replaced by others.

“The Credit Suisse AT1 wipeout led to concerns about the future of AT1s,” says Ms Kuppusubramanian. “However, any concerns about AT1s were laid to rest with the market recovering back to usual within six months. The turning point was the super-oversubscription levels on UBS AT1s in November 2023 – for reference, UBS acquired Credit Suisse. AT1 spreads recovered from a little above 1000 basis points after the Credit Suisse write-down and now trade close to 350 basis points on limited extension risk.”

Retention or discontinuation

For all the recent demand for the instrument, a slowdown in AT1 issuance is expected. Although a full phase-out in Europe is considered highly unlikely, Australia plans to discontinue AT1s by 2032 in favour of simpler and more effective crisis-management tools.

“Outside of Australia, whose supervisor is proposing to get rid of AT1s, all other jurisdictions have confirmed the importance and relevance of AT1s into the banks’ capital stack,” says Mr Lavier. “Everyone agrees that AT1s are excessively complex for a marginal benefit, but there is no willingness to discontinue or modify the features of the instrument. It does not mean that no evolution will come, but for the medium term at least, no big changes should be expected.”

For Ms Kuppusubramanian, the medium term will see AT1 securities remain attractive to investors globally due to the superior risk-adjusted rewards the instrument offers, albeit overpriced at current levels. She also notes that while there have been calls for reforms to the instruments’ structure, there is as yet no clear consensus on an alternative approach.

“Any changes to the structure of AT1s would be gradual and would include grandfathering provisions for the existing AT1s. This would imply a near certain likelihood of next-call-date redemptions,” concludes Ms Kuppusubramanian. “Therefore, we expect limited risk to current European banks’ AT1 investors and expect AT1s to remain highly liquid and rewarding assets.”

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Fraser Tennant