The EuropeanAT1 market appears well-positioned heading into 2025, despite broader economic uncertainties. Strong bank fundamentals, regulatory support, and attractive yields relative to traditional fixed income continue to drive investor interest. The expected lower rate environment in 2025, combined with banks' robust balance sheets, should maintain steady demand for these instruments.
Upcoming redemptions in 2025 are likely to create new issuance opportunities, potentially offering attractive entry points for investors. However, careful issuer selection and monitoring of bank fundamentals remain crucial given the subordinated nature of these instruments and their loss-absorption features.
Market Overview and Structure
Additional Tier 1 (AT1) bonds have evolved into a crucial component of European banks' capital structure since their introduction following the 2008 financial crisis. With a current market size of approximately $260 billion, these contingent convertible bonds (CoCos) serve as vital loss-absorbing instruments within the Basel III regulatory framework.
Key Structural Features:
Perpetual instruments with no fixed maturity
Loss-absorption mechanism triggered if CET1 ratio falls below predetermined thresholds (typically 5.125% or 7%). These mechanisms vary across issuers with Permanent write-downs, Temporary write-downs and Equity conversions as options. Recently we have observed a trend with issuers moving from Permanent write-downs to Equity conversions (e.g. UBS AT1s) as well as Temporary write-downs to Equity conversions (e.g. BNP AT1s). Such measures reduce the risk premium that surged post the Credit Suisse AT1 write-off.
Regulatory capital qualification under Tier 1 requirements
Call dates in these securities provide the issuers with an option to call that bond back. With the exception of few, most issuers call their instruments back as that implied ability to refinance at lower rates and hence credit positive.
European regulators created a specific "resolution" regime for AT1 bonds, distinguishing them from similar instruments in other markets like the US. This unique regulatory approach has shaped the development and characteristics of the European AT1market.
Fundamental Analysis
1. Liquidity Position and Deposit Dynamics
Liquidity coverage requirements are intended to ensure banks’ short-term resilience to potential liquidity disruptions. Banks should hold liquid assets to cover net liquidity outflows over a stress period of 30 calendar days and should maintain an LCR of at least 100%. 9 The LCR minimum requirement was set at 60% on 1October 2015 and it reached 100% at the end of the implementation period on 1January 2018.
LCR values reached 167% in June 2024, up from a level of 164% as of June 2023. Liquid assets increased while net outflows remained stable. All groups of banks increased liquid assets throughout the period under review.
LCR increased for retail-oriented banks, other specialized banks and other banks but decreased for corporate-oriented lenders.
Liquid assets increased between December 2023 and June 2024 (liquid assets represented 20% of total assets as of December 2023 and 20.06% as of June 2024). The increase arises mainly from the securities component, followed by Level 1 covered bonds and Level2 assets. Cash and central bank reserves declined mainly due to the gradual decline of central bank reserves.
Evolution of the composition of liquid assets relative to total assets.
Corporate deposits have shown strong growth. Since 2010, corporate deposits in the European Union have risen by an average of 6.6% annually, outpacing the 3.9% growth in retail deposits. During the COVID-19 pandemic, annual growth in corporate deposits surged to around 20%4.
Deposit competition has intensified. As interest rates increased in 2022-2023, there was a migration toward remunerated and fixed-term deposits. However, this trend largely stopped in the first half of 2024.
The COVID-19 pandemic had a major impact on deposit movements, with more significant shifts observed during this period compared to subsequent events like Russia's invasion of Ukraine or the March 2023 banking turmoil.
2. Asset Quality
Total eurozone bank lending is forecast to grow 3.1% in 2025 and 4.2% in 2026, up from just 0.2% over 2023 and2024.
Non-performing loans (NPLs) a share of total loans across the eurozone are forecast to rise to 2.3% in 2025and 2026, up from 2.0% in 2024.
Consumer credit in Europe is forecast to rise 3.0% in 2025, 4.2% in 2026, and 3.9% in 2027.
Commercial real estate (CRE)loans account for around 10% of overall bank lending in Europe.
The euro area banking sector maintained solid capital and liquidity positions in 2024, well above regulatory requirements, thanks to the tighter lending standards and reduced bank appetite.
Large European banks' commercial real estate (CRE) loan books are diversified, which helps mitigate CRE risk.
3. Profitability
Europe's largest banks could lose out on profit of at least €2.3 billion in 2025 as they grapple with headwinds from a lower-interest-rate environment, S&P Global Market Intelligence estimates indicate.
Net income at the continent's 25 biggest banks by assets will reach an estimated €160.75 billion for 2024, a figure projected to fall by close to 1.44% in 2025.
A "moderate decline "in European banks' pre-provision income is "inevitable" in 2025 and2026 because of lower deposit margins as short-term interest rates decline, according to an S&P Global Ratings report.
With lower rates, banks less reliant on NII are better off.
4. Balance Sheet Health
European banks' balance sheet health, as reflected in their AT1 (Additional Tier 1) instruments, remains robust in early 2025. This is characterized by Strong Capital Positions (Common Equity Tier 1 -CET1) ratio for euro area banks improved to 15.8% in mid-2024, well above regulatory requirements.
Along with-it corporate profitability has remained strong post-pandemic, contributing to the overall health of bank balance sheets.
In conclusion, European Bank AT1s continue to play a crucial role in banks' capital structures as we enter 2025. Despite facing challenges in 2024, the market has shown resilience and adaptability.
Key points to consider:
- Robust issuance: BBVA's recent $1 billion AT1 issuance with a 7.75% coupon demonstrates an ongoing investor appetite for these instruments.
- Regulatory support: European regulators have reaffirmed the importance of AT1s in bank funding structures, providing clarity on loss-absorption mechanisms.
- Upcoming redemptions: €15 billion AT1 bonds are set to mature in 2025, potentially driving new issuances.
- Market outlook: Expectations of lower interest rates in 2025 and banks' strong balance sheets are likely to support continued investor demand for AT1s.
- As the European banking sector navigates economic uncertainties, AT1s remain a vital tool for capital management, offering both challenges and opportunities for issuers and investors alike.
All investments carry risk, for more important information please read this disclaimer.
.jpg)
.png)
.png)
