AT1 capital bonds: Accessing bank capital

Dec 6th, 2019 | By | Category: Alternatives / Multi-Asset

By the ETF research team at Invesco.

AT1 capital bonds: Accessing bank capital

AT1 capital bonds: Accessing bank capital

What are AT1s?

AT1 contingent convertible bonds (“AT1s”) are securities issued by financial institutions that generally carry higher yields than traditional fixed income securities.

These bonds first appeared after the 2008 financial crisis and are designed to prevent contagion in the financial sector by acting as a readily available source of bank capital.

In the current low yield environment, AT1 bonds can provide a unique source of bank capital income with what we view as an attractive risk/reward profile that has been historically uncorrelated to traditional high yield and emerging market credit risk.

Source: Invesco.

Source: Invesco.

How do AT1s work?

The issuing bank’s total capital is comprised of CET1 (Equity + Reserves), AT1s and Tier 2 Capital. When the capital level falls below a trigger level determined by the regulator, AT1s are either converted into equity or written down to boost the firm’s capital levels.

This re-capitalization process aims to restore the bank’s capital back above the trigger level. It also acts as a safety net by imposing principal losses on the bank’s creditors (the AT1 bond holders) without affecting the interests of the depositors. AT1s can absorb losses prior to or at the point of insolvency with the goal of preventing wider financial distress.

Below is an illustrative example of an equity write-down scenario showing the stages of this trigger mechanism in action.

Source: Invesco.

Source: Invesco.

In this example, when the CET1 ratio falls below the trigger level the AT1s are converted to common equity to boost the issuers level of CET1.

AT1 universe by bond currency

Source: Invesco.

Source: Invesco.

Within the USD-denominated AT1 bond market, our index captures over 80% of European banks by market capitalization, including all the largest issuers, compared to only 65% exposure from the EUR-denominated market. This USD focus tilts the strategy to the largest, most globally diversified banks, which means less exposure to risks from smaller, regional banks in peripheral Europe.

Why consider Invesco AT1 Capital Bond UCITS ETF?

Our ETF offers diversified and cost-effective passive exposure to the USD-denominated segment of the AT1 bond market. The ETF may be particularly attractive to investors seeking income in the current, persistent, low yield environment.

Our ETF uses a customized version of the Markit iBoxx USD Contingent Convertible Liquid Developed Market AT1 Index. It is constructed with custom features to offer targeted exposure to the part of the AT1 universe with the most attractive risk-return characteristics.

  • Pure exposure to USD-denominated AT1 bonds
    Our ETF is the only UCITS ETF providing you with focused exposure to the USD denominated AT1 bond market. This allows us to gain access to the largest and the most liquid portion of the AT1 universe and provides much better trade execution than the GBP and EUR-denominated market
  • Low-cost access to the broad AT1 bond market in USD and EUR-hedged share classes
    Our ETF provides single currency exposure in USD-denominated bonds. In addition to our USD-denominated ETF, we offer a EUR-hedged share class for investors who wish to manage their own currency exposure. Our USD and EUR-hedged share classes have the same ongoing charge of 0.39%, which is currently the most cost-effective solution on the market.
  • Physically backed and managed in London
    Our ETF is physically replicated. It is also managed by our experienced EMEA ETF Portfolio Management team based in London. Our PM team was engaged in product design from day one to ensure liquidity and replicability.
Source: Invesco.

Source: Invesco.

(The views expressed here are those of the authors and do not necessarily reflect those of ETF Strategy.)

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