Investors who have profited from high-risk bonds known as AT1 bonds are facing a new reality: they may not receive their payments as expected. These bonds, which were introduced after the financial crisis, were typically sold by banks with a five-year period before an option to repay was triggered. In the past, investors would get their money back, and banks would issue new bonds. However, some banks are now changing their approach.
The recent turmoil in global finance, characterized by rising borrowing costs and the impact of the war in Ukraine, has made banks more cautious. Credit Suisse’s near collapse earlier this year resulted in the Swiss government-backed rescue that caused the elimination of billions of dollars of AT1 bonds. This event shocked investors and increased the cost for other banks seeking to sell their own bonds.
In light of these developments, smaller banks, including Austria’s Raiffeisen Bank International (RBI), have decided not to repay their AT1 bonds when the option arises. Instead, they are choosing to extend the bonds beyond the original five-year period and pay interest on them. RBI, for example, plans to skip the option to repay its 650 million euro ($716 million) AT1 bond in June.
This trend is a consequence of the substantial losses suffered by Credit Suisse’s AT1 bondholders. As a result, the market for such bonds, estimated at approximately $275 billion, is experiencing a split. Investors are now more cautious about investing in these bonds issued by mid-sized banks, leading to an increase in bond yields to over 10%.
The divide in the market is evident between large, strong banks and smaller institutions. Smaller banks are more likely to extend the bonds, which has frustrated investors. This market disruption has also affected investor confidence, with AT1 bond prices reaching three-year lows during the recent banking turmoil.
While some big banks, such as Italy’s UniCredit and Britain’s Lloyds, have repaid their bonds, other banks, including Societe Generale, UBS, and Santander, face upcoming repayment milestones. This situation presents a dilemma for banks that need to borrow or refinance. European banks are estimated to require over 400 billion euros of AT1 debt in the next three years. However, the current high cost of these bonds may discourage banks from issuing more and push them to explore other alternatives such as increasing equity, which could be even more expensive.
In summary, the landscape for AT1 bonds has changed, leaving investors uncertain about receiving their payments. The market is divided, with smaller banks opting to extend the bonds instead of repaying them, leading to increased bond yields and investor wariness. This poses a challenge for banks that need to borrow or refinance, as the high cost of AT1 debt may deter them from issuing more bonds.
($1 = 0.9084 euros)
