Happy AT1 returns seen despite quiet Q4

After a handful of deals in September, Additional Tier 1 (AT1) issuance in the last quarter of 2015 was confined to just one benchmark, but market participants said the lack of supply does not hold any negative implications for the asset class and that indeed the outlook for 2016 is promising.

Only Allied Irish Banks (AIB) tapped the market with a public AT1 issue in the last quarter, selling a Eu500m perpetual non-call five on 26 November (see separate article for more), which took AT1 issuance for the year to some Eu29bn on the back of some Eu10.5bn of supply in the third quarter, including in September names such as HSBC, Intesa Sanpaolo and Société Générale.

However, market participants said that the lack of supply is from a position of strength, rather than weakness.

“There was a bit of a risk-off phase, with the global growth scare in September/October, and then we now have the issue of rising US rates,” said Dierk Brandenburg, senior credit analyst at Fidelity. “So it’s not been a good time to buy, and those issuers who could afford to hold off did so — most issuers have enough capital right now so they are not forced into the market at any price, and that helps.

“Otherwise, we had three new issuers coming to the market, and that shows that the product remains attractive,” he added, noting, besides AIB, ABN Amro and Municipality Finance debuts in September (see separate articles for more). “There may be a bit of a macro overhang from the US, but come next year, I would expect issuance to resume.”

The asset class has meanwhile held its own in the secondary market, according to market participants. Nigel Brady, credit financials trader at Crédit Agricole CIB, noted, for example, that AT1 outperformed amid broader market weakness at the beginning of December.

“What has been notable is how relatively stable the AT1 market has been,” he said. “Even when you saw the iTraxx Main gap out 10bp-12bp, so 10%-15%, you were looking at 2 to 4 points in AT1, which is actually only 2%-4%.

“And the stability of AT1 compared to other asset classes is helping the product.”

According to Brady, this is tied in with the continued development of the investor base.

“A sea change has been the growth in dedicated CoCo funds,” he said. “Because AT1 remains outside investment grade mandates, there have been a lot of new funds set up specifically to buy this product and therefore remain outside investment grade restrictions, and they have been some of the biggest players.”

Such factors have contributed to a stellar year for AT1 in terms of returns. According to figures from Markit and Crédit Agricole CIB, CoCo AT1 returned 6.6% in 2015, making it the best-performing asset class.

“Overall it’s been quite a good year for CoCos, despite the supply and despite the volatility we had on the rates side,” said Brandenburg at Fidelity. “And the argument for generating strong carry out of this market, that’s going to be as relevant next year as it was this year.”

Brady and his colleagues at Crédit Agricole CIB forecast some Eu40bn of AT1 supply in 2016, compared with this year’s Eu29bn and some Eu42bn in 2014. But despite the pace picking up again, he does not anticipate supply pressures being an issue.

“We are well past the hump of the issuance,” said Brady. “People were scared of the figures that were being forecast — and we had our shaky moments back in 2014 and even in February this year — but generally the market has managed to digest it.

“The perception now is that ongoing issuance is going to be a lot more opportunistic.”

However, Vincent Hoarau, head of FIG syndicate at Crédit Agricole CIB, noted the wider market volatility in the run-up to the FOMC and sounded a note of caution about potential widening in the subordinated/hybrid space in the medium term.

“Expectations for the first quarter of 2016 are that there will be a large amount of Tier 2 transactions, new AT1 issuers and continued heavy supply in insurance Tier 2,” he said. “Those factors will increase pressure on issuers and further challenge performance.

“New issue premiums are set to increase or remain elevated across asset classes, with investors wanting to be fairly rewarded for the risk they are taking in primary, and to absorb potential upcoming shocks in capital markets. 2016 will be another challenging year with intense periods of volatility, and we may again see the stop-go, window-driven markets that characterised 2015, before things hopefully normalise in H2.”

Hoarau also highlighted that regulatory developments could again impinge on market dynamics.

“Meanwhile uncertainties regarding the treatment of senior debt or Pillar 2 disclosures remain intact,” he added. “These are negative factors for spread performance in senior and Tier 2, and sub-optimal for AT1 issuance.”