In an unexpected turn, Additional Tier 1 (AT1) bonds, typically considered among the riskiest and most complex debt structures, have demonstrated remarkable stability in the current volatile bond market. According to Bloomberg's rolling 10-day data, AT1s have been 75% less volatile than high-grade corporate bonds. This stands in stark contrast to mainstream bonds, especially long-dated government issues, which are being heavily impacted by concerns ranging from inflation to fiscal challenges and an influx of corporate supply.
This relative calm in AT1s highlights a strong investor appetite for yield, especially after the Credit Suisse incident in 2023 where $17 billion worth of AT1s were zeroed. Back then, AT1s were significantly more volatile, even 10 times more volatile than high-grade bonds. Romain Miginiac, a fund manager at Atlanticomnium SA, noted that AT1s exhibit "very little sensitivity to rates, little sensitivity to what's going on in the background in terms of macro," provocatively suggesting they are now as stable as it gets.
The demand for AT1s, also known as contingent convertible bonds, is driven by their elevated yields. The average yield on Bloomberg's global contingent convertible bond index is 5.7%, which is substantially higher than the under 5% for investment-grade corporate bonds and approximately 3.7% for government debt. About 80% of investors surveyed by ABN Amro Bank NV find simply earning the coupon income sufficient to meet their total return targets, leading to sustained high bids.
Investor interest is growing, with the number of fixed-maturity funds investing in perpetual AT1s nearly doubling since November. Unconstrained funds are also increasing their AT1 holdings in pursuit of higher returns amid lofty credit market valuations. Despite their "high beta" nature, which implies greater price swings, their current resilience is attributed to these robust yields.
However, this intense demand has led to a build-up of risk. AT1 spreads have reached record-tight levels, with the global CoCo index's spreads dipping below 200 basis points recently. This indicates investor complacency, as noted by Miginiac. Despite tight reset spreads and limited concessions, demand for AT1s remains strong, with recent issuances by BNP Paribas SA, Goldman Sachs Group Inc., and Bank of New York Mellon Corp. seeing significant oversubscription.
