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Taboos are being broken by banks in relation to high-risk bonds

Investors who reaped profits from high-risk bonds created after the financial crisis are now confronting a changing landscape where they may not receive repayments.

Taboos are being broken by banks in relation to high-risk bonds

These bonds, known as AT1 bonds or perpetual bonds, were typically sold by banks with a five-year option for repayment. Previously, investors would receive their money back, and banks would issue new bonds in return. However, the situation is evolving.

The recent tumultuous events in the financial world, including Credit Suisse's near-collapse, have prompted a shift in the market. Credit Suisse's crisis led to the annihilation of billions of dollars worth of AT1 bonds, leaving investors stunned and increasing costs for other banks seeking to sell similar bonds. As a result, some smaller banks are altering their approach and choosing not to repay the bonds at their maturity dates. Instead, they are extending the bonds indefinitely and paying interest on them.

Raiffeisen Bank International (RBI) in Austria is one such bank that intends to skip the option to repay its 650 million euro ($716 million) AT1 bond in mid-June. RBI's spokesperson clarified that the bank is committed to calling and refinancing the bond as soon as it becomes economically viable. Deutsche Pfandbriefbank and Aareal Bank, two German banks, have also opted to keep their bonds open, evading repayment milestones earlier this year.

The reverberations of Credit Suisse's bond wipeout continue to affect the market, which is estimated to be around $275 billion. Consequently, investors are growing more cautious about investing in AT1 bonds issued by mid-sized banks. Yields on these bonds have surged to over 10% from around 8% before Credit Suisse's rescue, as investors demand higher returns to compensate for the increased risk.

Alessandro Cameroni, a portfolio manager at Lemanik, noted that the AT1 bond market is undergoing a division. Larger, stronger banks are expected to act cautiously to avoid the stigma of not repaying bonds. However, smaller issuers that would like to repay their investors are finding it increasingly difficult. Peter Harvey, a fund manager at Schroders, acknowledged this split and commented that smaller, weaker banks are likely to extend their bonds, which may disappoint investors.

Investors who hold RBI's bond no longer anticipate repayment in mid-June after the bank missed a deadline to publicly announce its intention to repay. RBI cited the higher cost of issuing new bonds as a factor in its decision. The market for AT1 bonds has experienced a decline in investor appetite, as evidenced by the bonds' prices hitting three-year lows during recent banking turmoil.

Looking ahead, several banks face upcoming repayment milestones. Societe Generale, UBS, and Santander have substantial debt obligations in the next 12 months. However, the prevailing circumstances present a challenge for banks that need to borrow or refinance. Morgan Stanley analysts estimate that European banks will need to issue over 400 billion euros of AT1 debt in the next three years. The current high cost associated with issuing new bonds may discourage banks from pursuing this avenue.

Karsten Junius, chief economist at J. Safra Sarasin, highlighted the dilemma faced by banks, stating that increasing equity as an alternative would be even more costly. The evolving landscape of AT1 bonds underscores the vulnerability of global finance amid rising borrowing costs and geopolitical tensions.



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