Since Scope Ratings started providing ratings and research on European bank AT1 securities in 2014, the rating agency has highlighted these instruments’ primary role in providing a private-sector alternative for strengthening the capital positions of financial institutions, in addition to the issuance of equity. Hence, the rating approach remains focused on the coupon-cancellation and principal-loss absorption risks associated with the securities.

In a report published today, Scope considers that the weaker the credit fundamentals of the issuer, the greater the risk of investor losses – both coupons and principal. This has been very recently illustrated by the write-down of the AT1 (and Tier 2) securities of Spain’s Banco Popular – as part of its resolution – and by Germany’s Bremer Landesbank skipping coupon payment on its AT1 securities. In this context, the rating agency highlighted that the losses being experienced by investors in these two banks’ AT1 securities should not be extrapolated to all AT1 securities issued by other banks. “While certain risks are inherent to the securities given their loss-absorbing characteristics, the probability of incurring actual losses depends to a far larger degree on the credit fundamentals of the issuer”, says Pauline Lambert, Scope bank analyst and author of the report.

Scope’s report also points to the increasing risk of coupon cancellation as the hurdle for avoiding distribution restrictions continues to rise. This is due not only to the ongoing phase-in of the buffers comprising the combined buffer requirement (CBR), but also to the fact that CET1 capital is no longer the only relevant metric for assessing a potential breach of the CBR. Tier 1 and total capital are now also relevant and in the future TLAC/MREL requirements will plausibly be as well. While a breach of the later would not lead to an automatic restriction on distributions, it could impact a bank’s ability to pay coupons, as the respective institution would likely be under heightened supervision.

The agency added that this report is being published in conjunction with the annual update of its research reports on individually rated AT1 securities – a process which is currently underway. As a reminder, Scope rates AT1 securities at least four notches below the respective bank’s rating on senior unsecured debt eligible for MREL/TLAC (itself typically one notch below the bank’s Issuer Rating).

Scope’s report is titled 'AT1 Securities: Mind the Issuer' and can be downloaded HERE.