BACR 4 3/8 PERP [US06738EBT10] – /80 (10.559%)
We have come across an opportunity in the USD AT1 bond market which should be considered a core holding across all investors’ portfolios.
- Given the rally in yields and credit spreads globally, it’s rare to find an investment-grade security still yielding 10% plus in the current environment.
- Many investors are searching for USD assets. Being positioned in USD assets ahead of a flight to quality provides a hedge against an overselling of the AUD.
With European and US regional bank concerns subsiding since last year’s turmoil, it makes sense to look at the credit opportunity set commonly known as Contingent Capital (CoCo’s). These CoCo’s offer considerably more value than AUD AT1 Australian CoCo securities, whose coupons also have franking tax implications. The European and US CoCo market now stands at over USD250 billion (local USD currency) in face value of securities outstanding, representing over 100 issuers and multiple currencies. European banks have certain metrics that an AT1 CoCo issuer must meet, including Available Distributable Items (ADIs) and Maximum Distributable Amount (MDA) cushion which are transparent and readily available, so investors can assess the likelihood (risk) of a skipped payment. To date, only three European issuers have ever skipped on an AT1 CoCo payment.
In terms of why we like Barclays (Baa1/BBB+/A-) from a credit lens:
- The latest BoE stress test confirmed the increasing resilience of UK banks to economic tail risk – none of them were required to strengthen their capital positions.
- In common with other European banks, Barclays have greater visibility over its deposit base and higher Liquidity Coverages Ratios (LCR) respectively. Considering the events at Credit Suisse and US regional banks last year, banks with higher LCRs should trade tighter from a credit-spread perspective (all-else-equal) than banks with lower LCRs comparatively.
- Barclays strategy envisages higher income, costs savings and a modest redeployment of capital away from the investment bank. This should prompt rating agencies to review their Baa1/BBB+/A- ratings for an upgrade over the short to medium term.
Financial Metrics
It is rare that major European banks do not call their AT1 bonds (it has only occurred a few times amongst smaller European banks, and these were redeemed in subsequent periods). However, Barclays recently announced that they will call their AT1s callable later this year and will not be refinancing these securities given its comfortable AT1 capital level. This is credit positive in relation to call risk, with the Barclays USD AT1 callable from March 2028.
In the event of a non-call, the Barclays USD AT1s will revert to an implied forward coupon of US 5-year treasury curve rate + 3.41% or around 7.5%. This is considerably higher than the current 4.375% coupon. The increase in underlying interest rates means forward coupon resets are higher providing more incentive for the issuer to call. Furthermore, higher forward coupon resets as well as the currently deeply discounted nature of these securities place an inherent floor on the capital price of the bonds in the event of a non-call.
The Barclays CoCo has a common equity tier 1 (CET1) ratio trigger of 7%. Barclays currently has a CET1 ratio of 13.80% (as of 31/12/2023) which means CET1 capital would have to essentially halve to trigger – this is a fall of around GBP25bn. Barclays is currently generating around GBP8bn pa (as of 31/12/2023) so this would be a tail-risk event.
In the Credit Suisse scenario, Credit Suisse had substantially less CET1 capital which combined with the liquidity/funding issues it faced, caused the significant write down of their CoCo. In comparison, Barclays has very good liquidity/funding alongside plenty of CET1 capital, which accompanied with its higher underlying credit ratings, place it on different pedestal.
