An Italian Summer Renaissance?
We have been participants in the Additional Tier 1 (AT1) sector since its introduction in 2013, albeit with a high degree of selectivity, but the risk-reward has been obvious to us. The asset class has also demanded constant review and due diligence, as new regulatory changes have impacted existing securities and introduced variations to the documentation and structure of new issues.
For example, the latest news for AT1 comes from Fitch, which early next year is planning to release a new rating methodology for the banking sector. Fitch has an open period for industry feedback until year-end, but the new rationale looks likely to be implemented and, in our opinion, introduces an air of common sense. Effectively, for banks with a reasonably high buffer above their maximum distribution amount (MDA) level – falling below which can result in AT1 coupons being reduced or suspended – the rating differential between the issuer’s senior unsecured and AT1 will become four notches rather than the current five. This would result in around 40 EMEA-based banks enjoying a one notch upgrade on their AT1s. Importantly this would elevate a number of key AT1 issuers into the investment grade world, including ABN Amro, Barclays, Royal Bank of Scotland, Société Générale and Standard Chartered (among others).
The other interesting development that could potentially impact the sector is the forthcoming introduction of CRDV (Capital Requirement Directive V of the European Union), which is expected in mid-2020. While we have yet to see any clarification on the proposed changes, there has been rumour and conjecture that AT1 triggers may be changed to introduce a level of consistency. Currently some AT1 bonds have a common equity tier 1 (CET 1) trigger threshold of 5.125%, below which the bonds are either converted into equity or written down as part of the going concern, while other AT1 bonds are triggered at a CET1 threshold of 7%. Should a level of consistency be introduced and the 7% threshold be the new adopted norm (as it already is for UK and Swiss banks) then one would expect the low-trigger bonds would no longer count as AT1 capital, though they would likely be ‘grandfathered’ to their first call date (effectively making these old deals more bullet-like in structure). We still believe that the regulator would step in and determine a bank had reached a point of non-viability before it ever reached its CET1 trigger (5.125% or 7%), but in terms of extension risk this development, if confirmed, would likely have an impact on the way the low-trigger bonds would be perceived in the market.
As yet there has been no clarification over what will and will not be introduced by CRDV, but the banking sector continues to keep investors alert.