Relative value analysis via issuer and security level views can identify attractively priced Additional Tier 1 bonds.

Additional Tier 1 (AT1) bonds are issued by banks to meet Basel IV regulatory capital requirements. The AT1 market is established and liquid with a total value of $245 billion, with the largest issuers leading global and national champion banks based in the U.K., Switzerland and European Union.

The yield in the AT1 market is currently about 3.40%1 on average or a spread of 290 basis points over government debt with a duration of 3.5 years and BB/BB+ average rating profile. The AT1 spread is currently over twice the spread of similar-duration Tier 2 subordinated bank debt and also compares well to other BB/BB+ rated credit markets. In our view, the AT1 spread largely reflects attractive compensation for security features in AT1s, such as subordination and whether the issuer will call the bond as expected, but also, importantly, the exclusion of AT1s from major fixed income indices. We do not think AT1 spreads reflect any underlying concern with issuer credit quality. Bank credit fundamentals are strong, with common equity Tier 1 capital ratios currently above pre-pandemic levels, and profitability has strengthened this year, supported by improved commercial momentum and a material decline in provisions for loan losses. We also note that bank senior unsecured debt often trades very close to similar-rated non-financial senior debt, and bank Tier 2 subordinated debt often trades inside non-financial subordinated debt.

Relative value analysis via issuer and security level views can capture the complexity premium in AT1s. By issuer, U.K. bank AT1s offer spreads above that of EU peers with similar duration while U.K. banks exhibit stronger capital positions. The AT1s of national champion banks in peripheral Europe also stand out where their non-U.S. dollar securities offer attractive yields on a hedged basis, with higher reset spreads than their U.S. dollar securities. In terms of security features, attractively priced AT1s can also be identified in the intermediate part of the credit curve, which exhibits attractive spread roll-down for modest incremental duration. Also, AT1s with high coupons and high reset spreads are currently priced with modest yield give-up versus low reset securities of the same issuer, and also benefit from lower expected price volatility.

Overall, we believe bank credit fundamentals remain strong, and that relative value analysis through issuer and security level views can identify attractively priced AT1 bonds.