The growing importance of AT1 deal selection

The Additional Tier 1 (AT1) primary market has begun 2025 with a bang, with a sterling perpetual non-call seven transaction from NatWest that hit the screens on Wednesday morning set to take issuance over €16bn equivalent year-to-date, more than double the volume we have seen over the same period in each of the last five years (see Exhibit 1).

This is perhaps no surprise given investment bank syndicate teams have an easy sell to potential AT1 issuers right now – with market-moving headlines emerging from the White House almost daily, locking in deals at today’s slim spreads seems a sensible strategy.

Encouragingly, this surge of issuance has been met with very strong demand, with investors also keen to lock in attractive yields for high quality issuers. Earlier this week HSBC’s $1.5bn deal garnered order books of $10.5bn, supported by a rating of BBB and an annual coupon of 6.95% until its 2031 call date.

However, investors have also been given a timely warning against buying blindly from the primary market. UniCredit, one of Europe’s best performing banks in recent years, issued a euro AT1 last week with a 2032 call at a coupon of 5.625%. Both the deal’s spread and its reset level (which kicks in in the event of a non-call) was 330bp, a record low AT1 spread for UniCredit. At the time of issue, comparable UniCredit AT1s in the secondary market could be found at around 5.50% but with a reset almost 100bp higher than the new issue. As a result, we are not surprised to see the new deal trading about 1pt below par.

While many investors do not seem to be paying much attention to AT1 reset levels at the current time, in periods of spread widening these become much more important as a barometer of whether the market believes a bond is going to be called or not, otherwise known as “extension risk” (see our AT1 explainer). Importantly, when the replacement cost for a new AT1 is above the reset on the existing bond, the market tends to reprice the transaction to reflect a greater risk of a non-call, which can lead to a poor risk/reward trade-off for primary market deals printed in an environment of low spreads.

Now, we are not saying that low-reset bonds will not be called. Indeed, banks always consider many other factors (including reputation and the expectations of their investor base) when making AT1 call decisions. That said, we have seen many times before that in risk-off environments, the market can discount the possibility of a call altogether for AT1s that are “out of the money”, which can have a disproportionate impact on mark-to-market pricing for the holders of those bonds.

When spreads are tight, it is essential to consider the potential relative value on offer in secondary. It is currently possible to find bonds paying similar yields to primary transactions but with higher reset levels, which can help to mitigate mark-to-market volatility if sentiment weakens and the market becomes more focused on potential non-calls in low-reset AT1s.

The primary market pattern of 2025 so far is encouraging for the AT1 market, with record new issuance being met with strong demand for paper as many investors take the opportunity to lock in attractive yields for high quality bank names. However, investors should always be looking out for the best relative value and for AT1s it is frequently found in the secondary market.