Following on from the previous article on European Bank Earnings Update (click here), this week we focus on European Bank issuance in USD, with FIIG Research’s Peggy Lin discussing the metrics to consider when evaluating the risks and returns this sector offers.
Background
The Additional Tier 1 (AT1) European Bank issuance offers fixed income portfolios an attractive exposure, where typically these notes provide higher yields, an allocation to banks outside of the Major Four in Australia, and diversification through a USD-denominated holding. AT1 Capital is a component of a bank’s regulatory capital under Basel III and is designed to absorb losses while a bank continues to operate during financial distress (without the bank resorting to liquidation).
As part of our ongoing assessment of USD-denominated AT1 securities held by FIIG clients, we examine whether investors are being adequately compensated for the risks embedded in these instruments - namely credit fundamentals, provisioning strength (buffer against losses incurred), and structural extension risk (the risk an instrument isn’t called). Using a comparative lens across five core metrics – asset quality ratios, coverage levels, and reset margins - we identify relative value disparities and opportunities within this cohort.
Credit quality and provisioning: are yields justified?
Credit quality varies meaningfully across the banks, and for this assessment we have chosen to evaluate using the non-performing asset (NPA) to total loans ratio and provision to doubtful loans (coverage ratios) (Chart 1). These ratios asses the level of buffer that is held against losses incurred in a bank’s loan portfolios, noting loans may not always be repaid in full - borrowers can experience cash flow shortfalls that lead to delayed or partial repayments, and in more severe cases, loans may enter default. BNP Paribas (BNP) and Credit Agricole (ACAFP) stand out with around 2% NPA to total loans levels and coverage ratios above 80–90%, indicating strong underwriting and loss-absorption capacity. This means these banks have the ability to withstand a larger amount of losses compared to peers. Barclays (BARC) and NatWest (NWG) offer mid-tier provisioning and moderate NPA levels, while ING, HSBC, and SocGen show weaker provisioning (<50–60%) despite higher NPA ratios, implying higher downside risk in a stress scenario.
When incorporating maturity profiles and examining yields across assumed call dates (Chart 2), a clearer picture of relative value emerges. BNP’s 2029–2031 issues yield 6.5–7.0%, offering attractive income relative to their solid asset quality and manageable duration risk. Noting duration risk is the sensitivity to interest rate movements, with longer dated bonds more susceptible to larger capital price movements. In contrast, HSBC, ING, and SocGen show similar or higher yields (6.5–7.5%) despite weaker coverage ratios and elevated NPA levels. The higher income may look appealing, but it could reflect underpriced credit and duration risk. ACAFP’s 2034 bond yields around 6.5-7%, positioning it toward the longer end of the curve. Given the bank’s stronger balance-sheet metrics, its pricing looks reasonable, though investors must weigh the additional duration risk compared with peers such as BNP.
Reset Margins and Extension Risk: Who’s Paying You to Wait?
The risk that an AT1 Capital note is not called at its first call date, referred to as extension risk, is a key pricing driver in this segment. AT1 securities are structured with call dates, which gives the issuer the flexibility to redeem the note. We typically look to the reset margin to assess call likelihood: the higher the margin, the more likely the bond will become too expensive to the issuer to leave the bond outstanding after the reset date. In theory, higher reset margins incentivise calls, reducing duration risk and supporting tighter spreads. We are monitoring this risk more closely as reset margins have been trending downward in recent issuances. It is worth noting that there has been very little non-call activity by major European banks since the Global Financial Crisis. All the banks whose AT1s we offer have historically called their AT1 notes
Chart 3 highlights how reset margins vary across the peer group, offering insight into whether current yields adequately compensate for extension risk. BNP’s 2029 callable AT1 stands out with a reset margin above 500bps and a yield near 6.2%, suggesting strong call incentives and appealing relative value. Other BNP bonds—like the 2030, 2031, and 2035 lines—also cluster in the 280–360bps margin range while offering ~6.6-7% yields, appears reasonably balanced.
At the other end of the spectrum, ING 2027, HSBC 2030, and ING 2031 offer lower reset margins (~250–300bps) while yielding 6.4–7.0%, indicating potentially higher extension risk without clear yield compensation. BACR 2035 also screens weaker, offering yield above 7% but only modest reset margins, suggesting the risk of non-call may already be fully priced in. In the middle ground, ACAFP 2034 issue (reset margin ~350bps, yield ~6.8%) reflects solid credit fundamentals and fair relative value, though the longer tenor warrants a more cautious stance given the greater duration risk. SocGen 2028 and 2034 lines also sit in the mid-to-upper ranges (reset margins ~380–420bps, yields 6.8–7.6%), broadly in line with sector peers and offering no obvious mispricing signal.
Conclusion
Although USD AT1 spreads remain tight by historical standards, our analysis highlights pockets of relative mispricing. BNP’s 2029–2031 AT1s offer a compelling risk-adjusted return, combining strong credit quality, high provisioning coverage, and reset margins that support a high likelihood of call. ACAFP’s 2034 bond also appears fairly valued, reflecting solid credit fundamentals, though its longer tenor warrants more cautious positioning.
In contrast, longer-dated HSBC and ING AT1s offer only modest yield pick-up despite weaker credit profiles and lower reset margins. These structures may attract yield-seeking investors, but the combination of high extension risk and underwhelming compensation suggests a more defensive stance is prudent.
Against this backdrop, investors should also keep in mind that recent political headlines in France may contribute to short term spread volatility. Our base case remains that the core French banks are fundamentally well capitalised and that their solvency is not in question, but portfolio positioning should lean toward higher quality issuers and shorter dated exposures to help cushion against any political risk driven repricing.