In recent weeks, the banking sector’s “Additional Tier1” or “AT1” hybrid bonds, also known as “CoCo”, have shown notable instability in the financial markets. These bonds, issued by European banks since 2013 as part of regulations, are the most subordinated of all bonds that can be issued by these entities.
The unwinding of Credit Suisse’s AT1 bonds on 19 March negatively affected the entire AT1 market in Europe, leading to an increase in the risk premium on AT1 bonds from 500 basis points (5.00% at “call”) on 6 March to over 750 basis points (7.5% perpetual) on 20 March. Since then, spreads have tended to narrow, but remain volatile. It is important to note that these spreads are now mainly perpetual spreads and not call spreads.
AT1 hybrid debt risk premium
Although spread widening has not been as intense as in March 2020 during the Covid-19 crisis, the spreads reached on 20 March 2023 were close to record levels. Since the inception of the AT1 segment, only around 0.5% of sessions have seen higher spreads, equivalent to only 10 sessions in total. By the end of March 2023, only 6.4% of sessions since 2013 have experienced higher spreads.
While the AT1 segment initially experienced a significant decline in valuations, the increase in spreads has resulted in higher yields in this market. Yields at the call date (i.e. at the first possible redemption date of these bonds) range between 10% and 11%, while perpetual yields are between 8% and 9.5%. This provides, in our view, a sufficient yield spread to cope with the high risks inherent in this market segment over the medium to long term.