Following the AT1 shock, a closer look at bonds from Asian banks

Turmoil in the global banking sector made for a volatile first quarter of 2023 for financial markets, with Asian banks not spared from the turbulence.

Events including UBS’ takeover of Credit Suisse and the failures of US regional banks such as Silicon Valley Bank (SVB) unsurprisingly soured sentiment among investors of bank stocks and bonds — especially when it came to the Additional Tier 1 (AT1) market. The complete writedown of Credit Suisse AT1 bonds took many investors by surprise and made them question whether the asset class was still viable. AT1 capital securities are a type of riskier bank debt designed to take losses during a crisis, although conventionally shareholders will absorb losses before AT1 bondholders.

The Credit Suisse news in particular rattled investors in Asia and intensified a sell-off of Asian financial shares first sparked by the SVB collapse. It came as AT1s have been popular with investors from Asia in the past few years, due to these bonds’ high yield and perceived lower risk of principal loss.

But does this mean AT1s are dead? Specifically in Asia, as Asian banks’ capital structures come under scrutiny and investors reassess the risk inherent in bank stocks and bonds, market commentators are of the view that Asian banks will remain resilient and that there can still be noteworthy opportunities within their AT1 bonds.

Based on the fundamentals of Asian banks, fund managers generally do not expect the region to be significantly affected by the West’s banking sector woes. This is because Asian lenders are subject to more stringent regulatory frameworks, have diversified and relatively conservative business models, more contained investment books, and stable retail deposit bases. Furthermore, commercial and retail loans form the bulk of Asian banks’ assets, and as the chart below shows, the majority of their deposits — about 60% on average — comprise household current accounts.

Specifically in the AT1 bond market, fund managers also view Asian banks as resilient, given that they typically have more common equity on their books than the regulatory requirement. That can therefore help cushion the banks’ capital positions and profitability if there is any volatility or stress in the AT1 market.

Since the Credit Suisse takeover, numerous central banks in Asia — including the Monetary Authority of Singapore and the Hong Kong Monetary Authority — have confirmed that they remained committed to keeping the conventional creditor priority stance. That is, equity holders stand to absorb losses first before any AT1 writedowns. This has helped investor sentiment improve and demand for AT1 debt recover.

In the following list of commentaries, fund managers share their thoughts on the opportunities in fixed income when it comes to Asian banks’ debt, and how investors should measure the future for the AT1 market in this region.

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Asian banks and AT1s

Eastspring Investments, April 2023

“AT1s serve to strengthen a bank’s overall reserves and will thus remain a viable segment despite the dent in sentiment caused by the Credit Suisse debacle. Systemically important banks with AT1 exposures that have experienced improved capital and liquidity levels over the years should benefit from the flight to safety.”

“Asian banks seem adequately capitalised: In general, Asian banks have maintained higher than regulated capital adequacy ratios; their Tier 1 ratios are mostly above 15%. Post the 1997 Asian Financial Crisis, Asia embarked on financial and structural reforms, which not only shored up bank capital but also reduced the financial sector’s leverage.”

“Largest Asian banks are not over-leveraged: Under the Basel III framework, banks are recommended to maintain a leverage ratio of more than 3%... A higher ratio indicates that the bank can finance its assets with its equity and a higher likelihood of withstanding negative shocks. In Asia, the leverage ratios of the largest banks exceed 6%.”

Read more: Asia fixed income: a bright spot for investors

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Asian bond market outlook 2023

Lion Global Investors, 25 April 2023

“Now, ever since (the Credit Suisse AT1 bond writedowns), of course, we have seen the impact on AT1 bonds and bond prices have come off. Not only are AT1s lower, the tier-two bonds, which is ranked one notch higher than AT1s, also saw their prices weaken. That said, we are seeing some recovery.”

“Given the events, AT1s will take a longer time to recover. On that front, banks will have to wait before they can issue new AT1s. While that may take a while, I believe the broader market has mostly recovered. Therefore, I do not think that there is any real impact on the Asian bond market.”

“How should investors be positioned within Asian bonds right now? The interest rate environment has been volatile because of interest rate hikes… Taking into consideration the bank failures, it makes sense for investors to stay defensive.”

Read more: Investing lessons from the banking turmoil

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Credit Chronicle: Q1 2023

Ninety One, 20 April 2023

“In an emerging market (EM) corporate (credit) context, Asia saw the most outsized impact as that’s where Credit Suisse and UBS have a big broker/dealer presence… The fall-out in financials, particularly in AT1s, attracted the attention of many investors; while AT1s are not a common feature of developed market (DM) indices, they are a component of EM indices and in particular in the JPMorgan CEMBI, which is the most closely followed EM index.”

“That said, the make-up of banks in emerging markets is somewhat different to developed markets, with public markets focussed on large systemically important banks, where regulators can be much more friendly to bondholders than DM regulators. These banks tend to have a large and diverse depositor base and would typically be a beneficiary from flight to quality in deposits in the absence of any bank-specific risks.”

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Bank stability Q&A: one month on from turmoil, what next?

Schroders, 27 April 2023

“Japanese banks operate with a very ‘sticky’ deposit base — customers do not tend to move their money around. They are also under tight regulation so their capital position is solid. Unlike in the US, there is no relaxing of the regulations by bank size (in Japan).”

“If long-term interest rates go up in Japan, then we would expect regional banks to see some unrealised losses on their bond portfolios, as they tend to hold Japanese government bonds with longer maturities. It’s less of an issue for the major banks.”

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Emerging market banks are resilient

Franklin Templeton, 13 April 2023

“In our view, the risk that EM (emerging market) banks will experience the deposit-flight that select US regional banks and Credit Suisse witnessed is lower. This is due to divergent interest rate cycles, higher capital levels, and tighter regulation.”

“Interest rates in EMs never fell to the lows observed in DMs (developed markets), which ensured EM banks did not experience as dramatic a squeeze on net interest margins. EM banks also did not resort to buying large quantities of government bonds, as credit demand remained resilient. In combination with a high share of retail deposits in their liability mix, the risk of a liquidity squeeze similar to the one that US regional banks and Credit Suisse experienced is lower.”

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Read more: 

• What are AT1 bonds, Tier 2 capital, and CoCos?
• Webinar: Unlocking the potential of Asian fixed income

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