LAST week Barclays announced the call of its 7.75 per cent Perpetual Additional Tier 1 (AT1) Capital Note with a September 15, 2023 call date. This means that noteholders will get back their principal (ie face value) and the interest earned between June 2023 and September 2023. Today we’ll look at how the note performed, refresh our knowledge on the asset class, and evaluate replacement options.

The note was issued in 2018 and traded at a high of 111.6, a low of 77.5, and an average price of 102.6. The note performed very well, delivering consistent income at an attractive rate from an issuer of high credit quality.

How was it possible to get a 7.75 per cent coupon from a BBB+ (S&P)-rated issuer? Higher yields and coupons typically accompany AT1 notes. This is because of specific terms and conditions that create additional risks for investors.

AT1 notes sit right above equity holders in the capital structure — they are deeply subordinated forms of debt. The notes combine features of debt and equity and are treated as “hybrid” instruments. For example, many of these notes can be converted into equity if the bank’s capital ratios fall below a certain level. Similarly, the regulator can force the bank to withhold principal or interest payments if the solvency of the institution is at risk. The notes are undated, which means they have no official maturity date — rather, they have a series of call dates at which the issuer can elect to repay bondholders. Whether or not the note is called is a function of the interest rate and regulatory environment at the time. For these additional risks the noteholder receives a higher return.

Additional tier 1 notes were issued to help banks increase their capital base to better withstand future volatility and crises. They came about after the Great Financial Crisis of 2008 and have remained a key tool to help banks achieve compliance with Basel III. The terms and conditions governing the notes have evolved since 2008 but the key principles largely remain the same.

The fine print in the legal documentation and the regulatory environment will affect the performance of the note and the risks faced by noteholders. It is important for institutions to conduct rigorous analysis and stay up to date on the dynamic regulatory rules affecting the banks.

It is a great time to be coming into cash; bond yields have not been this high in many years. It is possible to get yields ranging from 8 per cent to 11 per cent on high-quality AT1’s in the current environment. To put this in context, consider that investment-grade plan vanilla bonds are delivering yields in the four per cent to six per cent range. High-yield plain vanilla bonds are roughly yielding between seven per cent and nine per cent. Naturally, there are exceptions to these ranges, and they are far from exclusive.

The key takeaway is to be sure to lock in higher yields with your new investments.

Marian Ross is vice-president, trading & investment at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm.

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