European Banks Flood Dollar Market for AT1 Debt

As the summer lull in the debt market comes to an end, European banks are swarming the dollar market for Additional Tier 1 (AT1) debt, driven by soaring investor demand for yield and duration. The first few days of September have witnessed an unprecedented supply onslaught, with record cumulative AT1 deals of around USD12 billion by European banks in just the first 10 days of the month. This surge in issuance has been led by national champions such as BNP and ING, as well as higher-beta issuers such as Alpha Bank, and even UniCredit, which had been notably absent from the AT1 space since 2021.

The strong demand for AT1s has led to substantial tightening from initial price thoughts, with nearly all issuances boasting strong oversubscription levels (5-10x). This has resulted in AT1 yields reaching their lowest point in the past two years, as banks lock in capital by opting for Perpetual Non-call 10-year bonds over the typical Perpetual Non-call 5-year ones. The AT1 market now stands close to USD250 billion, with YTD issuance of about USD40 billion.

However, the recent wave of issuance could also be influenced by banks aiming to avoid the uncertainty around the US elections in November, as well as fulfilling funding needs following 2Q results. The issuance uptick may also be a response to the heightened market volatility in August, following Japan's interest rate hike.

As the market remains open to lower-rung issuers with negligible new-issue premiums on offer, we expect a slowdown in issuance for the rest of the year. The key driver of medium-term AT1 issuance would be the upcoming regulatory changes. We consider the Australian Prudential Regulation Authority's (PRA's) proposal to scrap AT1s as a non-event for European banks, given their significantly strengthened capitalization with Common Equity Tier 1 (CET1) ratios in the mid-teens on average.

In conclusion, the surge in European banks' issuance of AT1 debt in the dollar market is driven by investor demand, regulatory changes, and the desire to avoid election-related uncertainty. However, the sustainability of this trend depends on market conditions, regulatory environment, and bank fundamentals. Investors should exercise selectivity in choosing AT1 issuances, explore other parts of the capital structure, and monitor regulatory developments to maximize returns in the AT1 market.