RBC's NVCC AT1 Issuance and Its Implications for Bank Capital Resilience in a High-Rate Environment

In September 2025, Royal Bank of Canada (RBC) announced a $1.35 billion issuance of Non-Viability Contingent Capital (NVCC) Additional Tier 1 (AT1) Limited Recourse Capital Notes (LRCNs), Series 7, marking a strategic move to reinforce its capital resilience amid persistently high interest rates. This issuance, with an initial coupon of 6.50% and a reset mechanism tied to the 5-year U.S. Treasury Rate plus 2.462%, reflects a broader trend among Canadian banks to leverage NVCC AT1s as a flexible, high-yield tool for capital management. For institutional investors, the transaction raises critical questions about the balance between risk-adjusted returns and the structural complexities inherent in these instruments.

Strategic Capital Structuring: A High-Rate Imperative

RBC's NVCC AT1 issuance aligns with its broader capital strategy to maintain robust Tier 1 capital ratios in a high-rate environment, where traditional funding costs have surged. The LRCNs, which mature in 2085 but carry optional redemption features subject to regulatory approval, provide RBC with long-term capital support while allowing flexibility to adjust to shifting interest rate cycles. The limited recourse structure—where investors' claims are restricted to assets within a dedicated trust—reduces systemic risk but introduces idiosyncratic exposure for holdersRoyal Bank of Canada announces NVCC AT1 Limited Recourse Capital Notes issue^[1].

This approach mirrors similar actions by peers such as CIBC and Toronto-Dominion Bank (TD), who have issued NVCC AT1s with yields ranging from 6.369% to 6.875% in 2025Bank of Montreal Announces AT1 Limited Recourse Capital Notes Issue^[2]. These instruments are designed to meet Basel III requirements for loss-absorbing capital without diluting equity, making them particularly attractive in a regulatory landscape emphasizing financial stability. For RBC, the issuance also reflects a proactive response to the potential for prolonged high rates, as the reset clauses ensure alignment with future market conditionsCIBC to Issue Aggregate $600 million of NVCC AT1 Limited Recourse Capital Notes^[3].

Risk-Adjusted Returns: Yield vs. Contingent Risk

The 6.50% initial coupon on RBC's NVCC AT1s is a compelling yield for institutional investors, especially when compared to the 4.50% offered on its earlier Series 1 LRCNs (2020) and the 6.369% seen in CIBC's March 2025 issuanceRoyal Bank of Canada announces NVCC AT1 Limited Recourse Capital Notes issue^[4]. However, the contingent nature of these instruments—where they can be converted to equity or written off in the event of a bank's insolvency—introduces significant downside risk. The 2023 collapse of Credit Suisse, which saw $17 billion of AT1s wiped out, remains a cautionary tale for investorsCredit Suisse And The AT1 Fallout: Why Investors Were Left With Nothing^[5].

Despite this, the AT1 market has shown resilience. European banks issued $40 billion in AT1s through September 2024, driven by strong demand for yield and favorable pricingBack in business: the evolving AT1 market^[6]. For RBC's NVCC AT1s, the risk-adjusted return on capital (RAROC) framework suggests that the high yield compensates for the elevated credit risk, particularly given RBC's AA- credit rating and its strong capital positionUnderstanding RAROC: Formula and Benefits of Risk^[7]. However, investors must also account for the uncertainty surrounding regulatory interventions, as seen in the Credit Suisse case, which could override contractual terms in extreme scenariosRevisiting AT1 bonds and navigating waterfalls going forward^[8].

Market Trends and Investor Considerations

The resurgence of AT1s in 2025 is driven by three key factors: the search for yield in a low-growth environment, the tax efficiency of NVCC structures, and the anticipation of rate cuts in 2026September sets AT1 record ahead of 2025 peak^[9]. RBC's issuance, with its 6.50% coupon and 5-year reset intervals, positions it to benefit from potential rate declines while mitigating reinvestment risk. For institutional investors, the challenge lies in balancing the income potential of these instruments against their structural vulnerabilities.

A critical consideration is the “reset spread”—the margin above the risk-free rate that determines future coupon adjustments. Instruments with high reset spreads, like RBC's 2.462% margin, offer better downside protection in a falling rate environmentGain the AT1 Edge - Why it makes sense to access^[10]. Conversely, low-reset AT1s are more sensitive to market stress, as seen in the 2020 pandemic, when AT1s lost 30% of their value compared to 10% for senior bondsA New Type of Security is Shaking up the Canadian Preferred Share Market^[11]. Active management and diversification across issuers and reset characteristics are thus essential for optimizing risk-adjusted returns.

Conclusion: A Calculated Bet for Institutional Investors

RBC's NVCC AT1 issuance underscores the evolving role of AT1s in bank capital structuring, particularly in high-rate environments where traditional instruments are less attractive. For institutional investors, the transaction offers a high-yield opportunity with a clear alignment to RBC's capital resilience goals. However, the contingent nature of these instruments—coupled with the lessons from Credit Suisse—demands rigorous due diligence.

The key takeaway is that NVCC AT1s are not a one-size-fits-all solution. Investors must weigh the income potential against the risks of regulatory intervention, market volatility, and structural complexity. For those with a long-term horizon and a tolerance for active management, RBC's NVCC AT1s—and similar instruments from high-quality issuers—could enhance portfolio returns while supporting the broader goal of financial system stability.