Compare three moments in the young life of the AT1 market: in February 2016, AT1 bond prices were hammered across European banks as Deutsche Bank seemed to be unable to pay its coupons; in June 2017, Banco Popular’s €1.25bn of AT1s were wiped out when the bank went into resolution; and on Tuesday, Nordea issued its first euro AT1 with a record low coupon of 3.5%.
The differences between the 2016 and 2017 events helps to explain the latest.
The resolution of Banco Popular changed assumptions about AT1s, as the market witnessed for the first time how European regulators would deal with the instrument if its issuing bank was failing.
The notes convert to equity or are written down when the issuing bank’s common equity tier one (CET1) ratio falls below a trigger level. They were designed as “going concern” capital, meaning that they can be converted or written down as a mechanism to help a bank get back on track before it actually fails and becomes a “gone concern”.
Popular had its AT1s written down after liquidity dried out when depositors withdrew money, not because the bank reached its CET1 trigger level. The write down was after the bank had become a “gone concern”, having hit its point of non-viability (PONV), according to the Single Supervisory Mechanism and Bank of Spain.
This made AT1s appear more attractive to investors because if AT1s are likely to be converted when banks are a “gone concern”, rather than a “going concern”, their risk assumptions can be changed.
Converting AT1s during a “gone concern” scenario would inflict losses on the bank’s subordinated debt holders. But as most struggling banks are, at worst, “going concerns”, AT1s are unlikely to be converted at all.
Another factor in the Popular resolution, in contrast to worries over Deutsche Bank’s coupons, was the lack of a sell-off across the asset class. Some other smaller Spanish lenders came under pressure, but the resolution did not rock the whole market.
The emergence of specialist bank capital funds has reduced the size and duration of sell-offs, as these funds see panic as an opportunity to pick up bargains and add to their holdings of AT1 credit.
The Popular resolution helped put the focus on individual banks, rather than the AT1 instrument as a whole. This benefits issuers with stronger credit profiles, such as Nordea.
Fast forward to Tuesday and the Swedish (soon to be Finnish) lender priced an AT1 with a coupon at 3.5% and more than €5bn in the final order book. This is the tightest AT1 issued in a core currency, smashing the previous record by 1.25%.
Investors in Nordea’s issue do not have to worry that a European weaker bank will disproportionately damage the value of their holdings. And they can (partially) thank the Single Resolution Board for that confidence.