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Whether in Europe or the United States, demand has become so strong that investors are accepting increasingly similar terms from banks with very different credit profiles. — Reuters
NEW YORK: In the market for junior bank capital – where distinctions between strong and weak banks matter most – investors are becoming remarkably indifferent.
Whether in Europe or the United States, demand has become so strong that investors are accepting increasingly similar terms from banks with very different credit profiles – a signal that traditional measures of relative value are breaking down.
The gap in costs between Europe’s strongest and weakest lenders has narrowed to record lows in this year’s Additional Tier 1 (AT1) bond sales, based on a measure known as dispersion in reset spreads, data compiled by Bloomberg shows.
Pricing in US preferred shares has compressed close to levels not seen since before the financial crisis.
It’s a development that’s pushed some longtime investors to the sidelines.
“We’re probably passing on more deals today than we’re actually participating in,” said Douglas Baker, head of preferred securities at Nuveen. Doubts about whether pricing adequately reflects the varying risks have given him pause.
Reset spreads are a key metric of value but also of the risk of skipping call options.
They represent the extra yield over benchmark rates investors receive on a preferred stock or AT1 bond once the initial fixed-rate period elapses.
Among European bank AT1s, the standard deviation in the reset spread of offerings in major currencies exceeding €100mil has collapsed to just over 52 basis points (bps) in 2026 from more than 110 bps a year ago, based on data compiled by Bloomberg.
Put another way, the tightest spread recorded both in 2025 and 2026 was near 250 bps – but the wides have shifted significantly.
In 2025 an investor could still find an AT1 that paid close to 1,000 bps. This year, the most generous spread is 520 bps.
In US lenders’ newly-minted preferred stock, standard deviation has more than halved to about 46 bps compared to the previous year.
In euro AT1s, those spreads are now “coalescing” around the low 300 bps area, Bank of America strategists led by Ioannis Angelakis wrote in a note to clients earlier this month.
A deal by Austria’s Erste Group Bank AG last week priced with a reset spread of 307.5 bps, entrenching the new norm.
“Everybody is unanimous that the market is too expensive but obviously for those who need to stay invested in fixed income, they have limited ways to outperform,” said Sebastien Barthelemi, head of credit research at Kepler Cheuvreux SA.
Investors chasing junior bank capital have been well-rewarded this year.
They quickly bounced back from the volatility sparked by the war in Iran to produce total returns of more than 3% year-to-date in dollar-hedged terms. That’s more than double gains in a similar index of global investment-grade corporate bonds.
Years after Credit Suisse’s US$17bil AT1 wipeout in 2023, the securities still offer a sizeable premium to peers: their average yield-to-call of 5.85% is more than a percentage point above those of global high-grade bonds.
Also known as contingent convertible notes or CoCos, the securities are trading close to the tightest levels since they were conceived as a way to buffer banks from risks in the aftermath of the global financial crisis. Those valuations leave investors more exposed in a downturn.
BofA strategists see reason for spreads in subordinated bank bonds to stay tight but caution that differences among banks in areas like profitability and exposure to energy-intensive loans are underappreciated.
“You’re picking up an incremental spread but is it really enough to compensate you for the true risk?,” said Nuveen’s Baker. — Bloomberg
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