One year on from the collapse of Credit Suisse - and what a year it has been for AT1s

Almost a year ago to the day, we were in the midst of banking sector turmoil, which started off with regional banks in the US and spilled over to Europe, eventually culminating in the forced merger between Swiss banks UBS and Credit Suisse.  

The event represented an existential crisis for the Additional Tier 1 (AT1) asset class as Swiss authorities upended the natural bankruptcy waterfall – AT1 investors absorbed losses, while shareholders walked away with some recovery on their shares. In the fallout, the Bloomberg AT1 EUR Coco index moved from a price of 177, in early March last year to 144 (or 19% lower) in a period of just a couple of weeks.

Following the failure of Credit Suisse, other European authorities rushed to reassure markets that the “Swiss solution” was not a blueprint for addressing future bank failures and indeed bankruptcy waterfalls would be respected during any such event in the future.  A few months later, in June, and with investor sentiment still fragile, UniCredit became the first bank after Credit Suisse’s demise to face a call of its benchmark AT1, and did so, without issuing a new bond. 

Subsequently, in August last year, Barclays also called its AT1, where arguably it was more economical to extend the bonds. Issuance in the sector quickly accelerated after UBS brought two AT1s to the market in November last year, receiving a combined order book that exceeded $30bn, which in our view represented a cathartic moment for the asset class. During this past year, we have not seen any material changes to the overall ratings of AT1s, and certainly there was no downgrade bias.

The markets took all these developments in their stride. After the initial 19% drop last year, as described above, the AT1 index has begun its march tighter, with the latest value sitting at 183. In short, we are back to pre-crisis levels and have added another 3% on top of that.

So where does this leave the asset class?

Firstly, it is quite clear that investors are treating the event as a one-off policy mistake by Swiss authorities with no read across to Eurozone and UK banks in the event of something similar happening.

Secondly, in terms of fundamentals, as we indicated most recently in December, we continue to see European banks as well positioned to face the current operating environment. We acknowledge that banks have been benefiting from initial interest rate rises so far, while seeing low deposit repricing and muted cost of risk – this is the nature of the hiking cycle. We expect this to change, as is usually the case at this stage in the cycle and expect a higher cost of risk and somewhat lower margins. 

Indeed, some pockets of the market may prove more challenging than initially anticipated, for example, commercial real estate, although this will likely depend on future rate trajectory. Notwithstanding that, save for a few specialised lenders, we believe that European banks have largely managed well the concentrations within their loan exposures, while also diversifying their revenue streams, so as not to rely solely on interest income. Capital ratios remain historically high and indeed some lenders have shown a preference to maintain them higher during this period of uncertainty.

Finally, in terms of valuations, the AT1 EUR index continues to trade wider in terms of spread versus high yield – a gap that has not yet fully closed post the events of last March. In the context of higher rates, headline AT1 yields remain eye catching compared to just a couple years ago, with, as an example, the investment grade-rated BNP $AT1 callable in 2031 offering 8%. The upshot is that we continue to see value in AT1s versus high yield noting that around 62% of the AT1 universe benefits from at least one investment grade rating.