Additional Tier 1 bonds may be the biggest winners in global credit markets if central banks start cutting interest rates.
The risky bank debt “could outperform all credit peers in 2024,” Bloomberg Intelligence strategists Mahesh Bhimalingam and Heema Patel wrote in a note on Wednesday. Global AT1s — also known as contingent convertibles — may have gains of more than 7%, helped by their high initial coupons, less expensive spreads and “higher correlation with credit’s expected yield rally from rate cuts,” they said.
Jeremie Boudinet, head of investment grade credit portfolio management at La Française Asset Management, has a similar view. AT1s, which were in the spotlight last year after US$17 billion ($22.8 billion) of Credit Suisse notes were wiped out, are a “leveraged play” on credit spreads’ correlation to government bond yields, he said.
“Spreads are supposed to reflect the health of issuers, but this is not the way they have been trading,” Boudinet said in an interview. AT1 “performance will be correlated to the direction of rates,” which paves the way for good performance in the context of cuts, he said. Boudinet sees only a few name-specific risks in the asset class after the Credit Suisse crisis was resolved.
The market for AT1s, which were created after the global financial crisis and provide a crucial capital buffer for lenders, was shaken last year by the Swiss bank’s writedown of its notes as part of the government-backed takeover by UBS Group AG. It took many months for the asset class to recover, but the market rallied late in 2023, buoyed by a new issue from UBS that attracted more than US$36 billion of orders.
The securities are seen producing outsized gains when rates fall, because they tend to have wider spreads and higher coupons than other debt.
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A multicurrency index of European banks’ AT1s by Bloomberg is down 0.98% in dollar terms since the start of the year, outperforming a global gauge of high-grade bonds but trailing junk debt.
Rates traders are still pricing in several rate cuts by major central banks this year, even though they have moderated their expectations in recent weeks.
