Higher risk premiums renew interest in hybrid bonds

The recent write-off of Credit Suisse’s AT1 capital notes has made the asset class more lucrative for investors, according to Robeco.

Last month, the Swiss Financial Market Supervisory Authority (FINMA) wrote off CHF 16 billion ($25.6 billion) in Additional Tier 1 (AT1) capital notes issued by embattled investment bank Credit Suisse.

The move was designed to ensure local competitor UBS would have enough capital to secure its $4.8 billion acquisition of Credit Suisse, helping to fund costs associated with the takeover. 

The hybrid bond wipeout rattled markets, casting doubt over the security of AT1 investments, particularly off the back of three banking collapses in the United States.

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However, according to international asset manager Robeco, investors with a higher risk appetite could reap the benefits of recent banking volatility by increasing their exposure to AT1 bonds.

“Robeco Fixed Income did not hold Credit Suisse’s AT1 bonds — nor those of Silicon Valley Bank or other Californian banks,” Robeco noted in its latest analysis.
 
“The reason we like AT1 now is that these events have increased massively the risk premiums on them.”
 
The asset manager said returns across the AT1 market could prove as lucrative as equity investments, with yields exceeding 8 per cent.
 
“Equity-like returns are possible in these AT1 bonds. It also shows that equity-like risks are involved in a very adverse, scarce, and idiosyncratic situation,” Robeco observed.

Central banks to push global economy into recession
 
Instability in global financial markets was also expected to be the prelude to a “traditional recession”.
 
According to the firm, aggressive monetary policy movements from the world’s central banks would continue to expose underlying vulnerabilities in the financial system.  
 
“A fast and aggressive hiking cycle will for sure reveal many problems. Which ones that will be, we don’t know, but a few real estate and banking accidents would all make sense,” Robeco observed.
 
Drawing from historical trends, the group said it expected the global economy to slip into recessionary territory later this year.  
 
“All-time series show the recession could start somewhere toward the end of the year — and we believe central banks will definitely cause one,” the asset manager noted.

In the meantime, Victor Verberk, co-head of credits at Robeco, said the firm’s strategy was to “buy on dips”.
 
“Spread markets reflect recession every now and then, driven by yield peaks, financial stress like that of recent weeks, or via an old-fashioned corporate credit crunch,” Verberk said.
 
The analyst added that he did not expect an easing in monetary policy settings any time soon.
 
“Be prepared for risk-free rates being very credible alternatives to other asset classes for longer,” he said.  
 
“It is payback time for years of negative yields and manufactured bubbles.”