European additional Tier 1 securities have been making the headlines lately, but they are still long way off from a worst-case scenario. 

The riskiest class of bank debt, contingent convertible bonds (cocos), has recently tumbled as the investors questioned the ability of the issuers to make coupon payments.

These worries are exacerbated by the relative novelty of cocos, most of which are referred to as additional Tier 1 (AT1), as an asset class. The instruments were originally devised in the wake of the crisis to ease the bail-in of banks by either converting debt to equity or writing it down. This conversion or writedown would happen if a bank’s capital ratio breached a specific trigger set in the bond’s documentation.

The high yields – often above 6% – quickly made AT1 popular with investors. Although the single largest issuer is China, according to tracking carried out by ratings agency Fitch,, AT1 is mainly the province of European banks, who had issued $132.33bn by the end of 2015 (see chart one).

chart one 2

Funding with AT1 capital is especially popular with Swiss and UK banks, which are jointly responsible for issuing a total of $73.74bn of AT1 debt to date. European issuance reached $60.99bn in 2014, peaking in the second quarter, and then slowed in 2015  to $38.44bn.

Weaker issuance

According to Fitch, issuance is weaker in 2016 as investors have been coming to grips with the risks of AT1 debt, such as missed coupon payments and bail-in risks. Banks, in turn, have also become reluctant to issue AT1 since the falling prices have driven up yields.

However, the possibility of the worst-case scenario of bail-ins is still remote for banks. In the case of the most popular AT1, with a 5.125% trigger, Fitch lists Deutsche Bank as having a 3.88% distance from the trigger, a comfortable capital cushion. Other banks are typically more than 4% away from the trigger, with 6.38% for BNP Paribas, according to Fitch (see chart two).

The spread is narrower in case of the AT1 with a 7% trigger, the second most popular instrument. In case of Santander UK the distance to the writedown trigger was 2.3% by the end of 2015, with two Dutch lenders, ING and Rabobank (based on third-quarter figures from 2015) being at a distance of 5.5% (see chart three).

chart two 2

The possibility of missed coupon payments is admittedly greater. According to EU regulations, banks that do not meet combined buffer requirements face restrictions on distributions and are subject to a maximum distributable amount (MDA) limitation. The MDA pool includes distribution of profits, common equity Tier 1 payments, variable remuneration and AT1 payments. The European Banking Authority specified in December 2015 that the capital buffer must include both pillar one (public capital requirements) and pillar two – capital add-ons specified by the banks’ supervisors for risks not covered under pillar one.

Should the bank be unable to meet the combined buffer requirements, it would be faced with MDA restrictions on these payments. Total Basel III capital requirements are gradually being phased in until 2019. According to Fitch, if banks today were faced with the end-state 2019 combined buffer requirements instead of the phased-in ones, some could find themselves with a breach.

According to the data from Fitch, two issuers of 5.125% trigger AT1 – UniCredit and BNP – would find they were lacking headroom under the 2019 combined buffer requirements, with UniCredit being at -0.05% and BNP Paribas at -0.5%. In the case of the 7% trigger AT1, no banks would find themselves with a breach, although for some – Rabobank, HSBC, Barclays and ING – the distance would be less than 1%.  

chart three 2

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