AT1 CoCo bond ETFs feel the heat from Credit Suisse collapse

Mar 20th, 2023 | By | Category: Fixed Income

ETFs providing exposure to Additional Tier 1 (AT1) bonds have come under pressure as a result of stresses in the global banking system following the demise of SVB and Signature in the US and Credit Suisse in Europe.

AT1 CoCo bond ETFs feel the heat from Credit Suisse collapse

The value of Credit Suisse’s AT1 bonds have been written down to zero.

AT1s, also known as contingent convertible (CoCo) bonds, are a specific type of debt instrument issued by European banks and other financial institutions.

They include a mechanical trigger that can write down the value of the bond or convert it to common equity if the issuing bank’s level of capital drops below a certain threshold.

AT1s, which act as a buffer for banks in extreme conditions, were a key innovation following the Financial Crisis of 2007-08.

Designed to shift banking risk away from taxpayers and onto bondholders, these bonds have historically had a lower credit rating, and in turn higher coupons, than the senior debt issued by the same issuer.

While the performance of AT1 bonds can be sensitive to changes in the business cycle, these securities became very popular due to their attractive yields during the low interest rate environment. Many investors also likely held the notion that write-downs of AT1s due to adverse events would be highly unlikely as the average European bank would have needed to lose almost two-thirds of its capital to breach contractual triggers.

There are currently two ETFs in Europe offering targeted exposure to the AT1 bond market – the $1.2 billion Invesco AT1 Capital Bond UCITS ETF (AT1 LN) and the $270 million WisdomTree AT1 CoCo Bond UCITS ETF (CCBO LN). Invesco’s AT1 ETF focuses on the US dollar-denominated AT1 bond market, the deepest and most liquid in which European banks issue AT1 bonds, while the WisdomTree fund has a broader scope in that it tracks AT1 bonds denominated in US dollars, euros, and pound sterling.

As of the market’s close on 17 March, both funds have fallen approximately 9% since a bank run on 10 March caused the US’s Silicon Valley Bank (SVB) to fail, marking the start of the current crisis in the global financial system.

YTD performance in USD for the Invesco AT1 Capital Bond UCITS ETF (AT1 LN) and WisdomTree AT1 CoCo Bond UCITS ETF (CCBO LN).

The ETFs are suffering further pain today, following yesterday’s announcement from Swiss financial regulator Finma that Credit Suisse’s AT1 bonds, which were valued at approximately 16bn Swiss francs ($17.3bn), would be completely wiped out as part of the bank’s merger with UBS.

Credit Suisse is a relatively significant issuer in the AT1 bond market – as of 17 March, the firm’s AT1 bonds are thought to have accounted for approximately 3.0% of the Invesco ETF and 2.7% of the WisdomTree ETF.

Both ETFs plummeted around 12% in early trading on Monday 20 January before paring back some of those losses by lunchtime.

The complete write-down of Credit Suisse’s AT1 bonds has likely shocked many investors who might have presumed these bonds offered better protection than ordinary equity, leading to a more pronounced sell-off of similar securities from other European banks.

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