Don't miss out on scarcity premium in AT1s

The first four months of this year have seen €11.6bn in gross Additional Tier 1 (AT1) issuance from European banks, across euros, dollars and sterling markets. Looking at the same period over the last five years, this gross issuance represents the second highest amount of AT1s brought to the market, only trailing 2023, which saw €13.3bn in new paper. For some context, the total amount outstanding in AT1s across euros, dollars and sterling is around €190bn.

However, while the gross issuance so far this year has been certainly material, both in absolute and in historical context, it shows only part of the picture around the supply.

Just over the course of last couple weeks, European banks announced calls for around €7.0bn in AT1s, which represents nearly 4% of the entire universe or around 30% of AT1s callable in 2024. All bonds that have come to the first call date this year have been indeed called, which is echoing the issuer behaviour we have seen in vast majority of cases in the past – as we pointed out earlier this year. The latest announcements bring the total amount of AT1s that have been called or tendered this year to €13.9bn–above €11.6bn in gross supply that we have seen. This figure increases to €19.0bn if we consider AT1s that have been called late in 2023 but redeemed this year. Looking ahead, markets expect total supply for the year to be around €25bn -€30bn. With €10.0bn in securities still callable for the reminder of the year, the net supply in AT1s in 2024 is not expected to be material in the context of the total amount outstanding.

In our view, the muted net supply picture for this year is indeed a mere representation of bigger trends in the AT1 space. The trend has been of rapid growth in the issuance of securities since the first print by BBVA (in May 2013) until end 2021. During this time, European banks gradually phased out legacy junior subordinated Tier 1 securities that did not conform to the latest regulatory requirements and replaced those with AT1s. By end 2021, many banks achieved optimal level of AT1 capital within their regulatory capital structures.

At this point, we would note that bank capital (incl. AT1 capital) issuance is unique in contrast to non-bank corporates, as it is influenced directly by capital requirements imposed on banks. Pricing, balance sheet changes, and general funding needs are also very important considerations in issuance of capital instruments, but in our view, banks will be generally less sensitive around the cost of AT1s, as long as it is lower than the cost of equity.

In terms of capital requirements that influence the amount of issuance, those are based on both risk-weighted assets (RWAs) and leverage exposures. In the absence of significant growth in RWAs and leverage in the last couple years, the need for AT1 issuance has remained broadly unchanged, and in some cases, has reduced. The latest total value of Bloomberg European Banks CoCo Tier 1 Statistics Index is €167bn, which is below the peak in early 2022 of €189bn– the decrease of this magnitude can be explained by the write-off of Credit Suisse AT1s. This size compares to US high yield (HY) of $1.34tn, euro HY of €380bn, and sterling HY of £40bn. Going forward, we would note that most of the regulatory changes have been largely absorbed in the current capital positions of European banks. Additional growth in European banks’ balance sheets may be offset by the efforts to optimise RWAs, for example through synthetic securitisations, and therefore reduce capital requirements. Even in the absence of optimisation efforts, we do not expect significant balance sheet growth, as this normally broadly trails growth projections of underlying economies. All of that being said, we would not expect the total amount of European AT1s outstanding to exceed the peak figure of early 2022 any time soon.

Taken together, we see the recent muted net AT1 issuance as part of the broader trend related to the replacement of legacy junior subordinated instruments, which culminated in early 2022. Considering our view is for limited growth of European banks’ balance sheets and rather static capital requirements in the coming years, we see limited scope for future increase in net issuance of bank capital instruments – this differentiates AT1s from corporates/HY, where the supply is more closely influenced by pricing and funding needs. We believe this trend will provide a strong tailwind to AT1 valuations in the coming years and could eventually lead to scarcity premium for these securities. It is likely that bond prices are better supported as a result, even during periods of market weakness.

Source: Bloomberg 1 May 2024