Credit Suisse Tier1 v Equity

[unperplex]

Does anyone know who/what sort of investor is holding these CS Tier 1 CoCos ?
Would there be many private investors,like us, or would they be largely held by institutions ?
If the latter, which institutions ?
Are the “wealth preservation” ITs (eg: Capital Gearing, Ruffer etc. - neither of which I hold) likely to hold any, or would they limit themselves to UK or US Treasury Bonds ?

[Alaric]

Does anyone know who/what sort of investor is holding these CS Tier 1 CoCos ?
Would there be many private investors,like us, or would they be largely held by institutions ?
If the latter, which institutions ?

The FSA attempted to ban private individual investors from holding CoCos and may have suceeded. Perhaps those certified as sophisticated investors would be allowed them.

Being fixed interest, admittedly with default possibilities, it would be investors fishing in the riskier end of the fixed interest market. What are they denominated in? If Swiss Francs, Euros or US Dollars, that would reduce the likelihood that UK funds held them.

[unperplex]

Thanks.
Most helpful.

[OldBoyReturns]

Does anyone know who/what sort of investor is holding these CS Tier 1 CoCos ?
Would there be many private investors,like us, or would they be largely held by institutions ?
If the latter, which institutions ?
Are the “wealth preservation” ITs (eg: Capital Gearing, Ruffer etc. - neither of which I hold) likely to hold any, or would they limit themselves to UK or US Treasury Bonds ?

Mainly institutions such was PIMCO in fixed income funds. Also some wealth managers who will now have unhappy clients. More colour from Reuters here:

"Funds managed by Lazard Freres Gestion, PIMCO and GAM Investments were among the most exposed as of end-February to Credit Suisse AT1 debt in terms of portfolio weighting, leaving them potentially vulnerable to losses from the bond write-off"

Google "Credit Suisse AT1 bondholders consider possible legal action -law firm" for full article. I cannot post links for some reason.

[ayshfm1]

My view - the Swiss Government were absolutely bonkers to wipe out AT1 Coco's.

Basically as an asset class it's dead under their jurisdiction and I imagine holders in other jurisdictions are going to be nervous.

There was a careful balancing act to be done between return and risk and the whole low risk model (and low risk premium) has at a stroke been destroyed, they are now riskier than equity without the return.

[BondSquared]

Both the ECB and BoE have come out with statements trying to limit the damage to the AT1 market:

https://twitter.com/ecb/status/1637754404496461826

https://www.bankofengland.co.uk/news/20 ... -hierarchy

which, of course, carries absolutely no weight - they would have done exactly the same as the SNB/Finma in a comparable situation. The Swiss taxpayer is indemnifying UBS for losses of up to ~USD10bn via a guarantee (UBS takes first $Xbn losses, taxpayer afterwards) - so creating a cushion of USD17bn of capital to protect the taxpayer from coughing up by wiping out AT1s was the logical step. The damage - the destruction of the AT1 market - will be borne by other jurisdictions, where banks will either never be able to sell AT1s again or only at a huge cost going forward.

Hasn't made them any friends abroad, but for $17bn it's probably an ok trade to lose a few friends ... the Swiss may have to pay for their own drinks at the next global central bank/BIS offsite ...

[GoSeigen]

I take the view that while banks are doing well Cocos will be fine, and that's the point really, isn't it?

So if you take a view of the banking sector as a whole, and that it is tightly regulated and awash with capital, then Credit Suisse events will be few and far between and the premium required on Cocos will be there, but not prohibitively high IMO.

Anyway IIRC in some cases they were being issued at yield spreads of some 7% over gilts -- sorry just plucking this figure from my memory, but there should be some data somewhere. 7% seems to me to be a tempting premium for an investor if no major upsets are going to happen with the whole sector; obviously when regulation is reversed at some point in the future Cocos become toxic but that is always the way with markets. For the time being the market still doesn't like banks and that is bullish for investors in their securities, including Cocos.


GS
[Edit: Case in point Terry Smith never invests in banks ]

[ayshfm1]

I've never been a fan of these Coco's, they looked like something you bought with other peoples money.

I've seen the statements by the BoE and the ECB trying to reassure buyers. I grudgingly give the BoE some credibility as it has never acted fast and lose with capital hierarchy but that might simply because it hasn't been put in a difficult position. The ECB on the other hand has and did (bond value became defined by who owned it rather than it's T&C's) thus has no credibility in eyes, in short, buying European paper has proven jurisdiction risks and should carry a commensurate risk premium, which for some reason it doesn't.

From the Reuters article it seems clear that it was written into the prospectus that the capital hierarchy was something that could be ignored in some scenario's and thus those that bought them (on behalf of others no doubt) did so knowing they were buying an instrument that had potential outcomes (catastrophic) that were both arbitrary and political, they got what they deserved.

Still it's one thing to write that clause into a contract and quite something else to actually use it. AT1 is going to be a hard sell going forward I reckon.

[Gan020]

AT1 is going to be a hard sell going forward I reckon.

AT1's are a necessary part of the financial structure of banks.

Investors will adjust the coupon required for the risk. If we now have a scenario where AT1 is subordinated to equity, the coupons are going to go up significantly. I don't think that is the likely outcome though. I think it most likely for new issues the prospectus will have additional wording to ensure the equity is subordinated to the AT1's.

Regardless the coupon is going to go up by something.

[hiriskpaul]

Ordinary share capital is subordinate to AT1s. That is a fact. If CS had gone into liquidation, assets disposed of, the ords would have been at the bottom of the pile when it came to any distribution.

CS did not go into liquidation. It may have done, but before that happened, a Write-down Event (as described in the AT1 T&Cs) kicked in causing the $17B of AT1s to be written down to zero. That made the bank more viable and UBS were prepared to pay $3B for it. As far as I can see the AT1s did precisely what they were designed to do. Not completely though as the Swiss taxpayers have still taken on some risk, which is something the new banking regulations were designed to try and avoid. It will be up to lawyers and courts to decide whether a Write-down Event did actually occur in this case, but on my amateurish reading of the prospectus it seems highly likely that it did.

[hiriskpaul]

Thinking about it though, £1000 denomination is not at all uncommon for bonds.

[ayshfm1]

I think it's more accurate to say that these AT1 are in some scenarios subordinate to equity, and that this would be such a case as they are demonstrably gone and some equity is not.

The definition of a write down event is subjective, it could be political, I would argue, at least in part, it was in this case. The Swiss Government has been at pains to state that this is a trade sale and it can only do that because equity was "sold" to UBS, had it written the lot down the it would be hard to make that argument.

AT1 is only part of bank financing if it can be sold with a reasonable coupon and it will only carry a reasonable coupon if the risks can be approximated. All bets are off once it becomes a political calculation rather than a solvency/liquidity one.

For example why did these AT1 not convert to equity? They could have been treated the same as shareholders then. I can think of reasons why, so it's more a rhetorical point.

[hiriskpaul]

I think it's more accurate to say that these AT1 are in some scenarios subordinate to equity, and that this would be such a case as they are demonstrably gone and some equity is not.

The definition of a write down event is subjective, it could be political, I would argue, at least in part, it was in this case. The Swiss Government has been at pains to state that this is a trade sale and it can only do that because equity was "sold" to UBS, had it written the lot down the it would be hard to make that argument.

AT1 is only part of bank financing if it can be sold with a reasonable coupon and it will only carry a reasonable coupon if the risks can be approximated. All bets are off once it becomes a political calculation rather than a solvency/liquidity one.

For example why did these AT1 not convert to equity? They could have been treated the same as shareholders then. I can think of reasons why, so it's more a rhetorical point.

The AT1 was not converted to equity because that was not in the terms. They were not convertibles. Equity holders would quite rightly object if they were being diluted by AT1 conversion when the terms say the AT1 should be wiped out. Some bank capital is convertible of course and arguably it might be better if it always was. That would at least negate the cries that the hierarchy had been upended when regulatory events are triggered.

It can be difficult to avoid subjectivity when it comes to regulatory decisions. The holders can of course seek redress through the courts if they think the regulators have acted unreasonably and the investors in this type of paper are very able to look after themselves in that way. They are also very able to understand the risks of their investments.

Anyone who says they didn't understand what they were buying would get no sympathy from me in this instance. There was no attempt to hide the risks of a Write-down Event in small print, or to interpret the Event in unobvious ways, as was the case with the Lloyds ECNs. At least, I have yet to read anything that makes me think anything dodgy went on here.

The whole point of Basle III, etc. is that bank investors take the risks of too big to fail banks rather than taxpayers. It seems to have worked.

[murraypaul]

It will be up to lawyers and courts to decide whether a Write-down Event did actually occur in this case, but on my amateurish reading of the prospectus it seems highly likely that it did.

From what has been quoted, all that is required is that the regulators had a reasonable belief that it was required, which would be very hard to disprove.

(b) customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible, CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving CSG’s capital adequacy and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business.

1) "customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible" - I think clearly true
2) "CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have,"
2a) "the effect of improving CSG’s capital adequacy" - Clearly true
2b) "and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business." - dependent on the judgement of the regulator

[ayshfm1]

I had a quick look at the Lloyds AT1's and they are pretty scary, why would anyone buy such a thing!

Anyway the key catch all clause was agreeing to be bound by a BoE bail in and when I looked at what that meant, there are bunch of guidelines but the bank can ignore them if it sees fit.

I draw from this that whilst the BoE may intend to abide by the hierarchy it is in no way obligated to do so.

Caveat Emptor.

I've come to agree with the comment on never owning them but being very pleased when there are lots in issue and owning debt that is senior.

[hiriskpaul]

It will be up to lawyers and courts to decide whether a Write-down Event did actually occur in this case, but on my amateurish reading of the prospectus it seems highly likely that it did.

From what has been quoted, all that is required is that the regulators had a reasonable belief that it was required, which would be very hard to disprove.

(b) customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible, CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving CSG’s capital adequacy and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business.

1) "customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible" - I think clearly true
2) "CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have,"
2a) "the effect of improving CSG’s capital adequacy" - Clearly true
2b) "and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business." - dependent on the judgement of the regulator

Very hard to disprove yes, but not impossible. Would likely require the use of expert witnesses.

[Holts]

The view then is CoCos did their job and indeed in certain scenarios equity can remain as the CoCo gets written off .

However the ECB and BOE are , perhaps desperately, trying to re assure us that in their view equity goes first then CoCos next .

Co Co yields need substantially adjusting .

[Newroad]

Hi Unperplex.

Re your earlier question as to who was holding the CS AT1 instruments wiped out, I believe I saw CNBC flash up earlier that the two biggest holders are understood to be Pimco (around £807M) and Invesco (around £370M).

Regards, Newroad

[hiriskpaul]

The view then is CoCos did their job and indeed in certain scenarios equity can remain as the CoCo gets written off .

However the ECB and BOE are , perhaps desperately, trying to re assure us that in their view equity goes first then CoCos next .

Co Co yields need substantially adjusting .

I don't think we can generalise. The CS terms look particularly awful to me and I don't know to what extent these terms are common to other banks in other jurisdictions. Certainly there are many CoCos that convert to equity. The clue is in the name! The equity may of course end up being written off!

[hiriskpaul]

ps, just one example, but the Lloyds ECNs would have converted into ordinary shares if the CT1 ratio dropped below 5%. As it turned out, the real risk was with the capital disqualification event, which enabled them to be redeemed early!