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Preference Shares & Subordinated Bonds COVID Bail-In Risks

Gilts, bonds, and interest-bearing shares
ignotus20
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Preference Shares & Subordinated Bonds COVID Bail-In Risks

#302969

Postby ignotus20 » April 24th, 2020, 3:57 pm

I own a fair selection of bank preference shares and subordinated bonds, mostly dating back to not long after the 2008 crash (circa 2009-2013). Stuff like LLPC, BOI, NWBD, Co-Op (42TE etc), SAN, STAC, HALP etc. These are split across my ISA and SIPP. I recall there was a fair bit of turbulence with these at different times but for the most part, very few were actually bailed in and the yields have mainly fallen until this year.

When the COVID crisis looked like it was coming our way in late Feb/early March, I sold most of them off in my ISA but kept the ones in my SIPP (the ratio of holdings is about 50/50). This was on the basis that I thought the prices would fall and I wasn't sure about whether the coupons and dividends would continue. I didn't know this for definite, hence why I only sold half so if I was wrong, I would still have some skin in the game (and continue to receive some income). The prices when I sold were still relatively close to the highs and my reasoning was that the worst case would be buying them back for not a great deal more than what I sold them for (currently they're roughly 10-20% cheaper).

My rationale for selling is that while the banks aren't as badly affected by COVID, they lend money to many of the companies who are. In a sense the situation is the inverse of 2008 where the credit crunch eventually filtered through to the wider economy, this is businesses being unable to pay their bills which will eventually filter back to the banks. Either way, the outcome is defaults and that may lead to banks not being able to honour their own obligations as a consequence.

My question is what is the situation with subordinated debt now if a bank gets into trouble? I know there are different clauses for each instrument (e.g. cumulative dividends for some, 4 for 3 in the case of NWBD etc) but I seem to recall the rules had been changed so bond holders could be bailed in more easily than during the banking crisis. So what is the true bail-in risk for subordinated bank debt and has the market underestimated it?

johnhemming
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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303002

Postby johnhemming » April 24th, 2020, 5:34 pm

There is, of course, the question as to what price people are bailed in at. However, there is a bail-in risk for some instruments.

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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303032

Postby 88V8 » April 24th, 2020, 8:24 pm

ignotus20 wrote:My question is what is the situation with subordinated debt now if a bank gets into trouble? .... what is the true bail-in risk for subordinated bank debt and has the market underestimated it?

On the plus side, the banks are much better capitalised than in 08.
On the minus side, indeed there is now a bail-in risk which on the whole there wasn't before.
On the get real side, the market has decided that the major banks are in no danger from this overblown blip and I agree, although we may see a prolonged pause in divis on the ords.

I hold most of the usual FI suspects, have sold nothing - you did well to sell in Feb - and have been adding.
If I were you I would be buying back so as not to waste your prescience.

That said, I try not to overstuff myself with Financials nowadays as there will eventually be another crash; already one sees the straws in the wind of reducing LTV requirements. So do not forget the non-bank BWRA and BP.B, and ELLA, and of course the Co-op is no longer a bank.

I've also been buying MBSP, PF21 and IPF2 although, yes, more Financials, hard to get away from them.

Then there's PM01 and ENQ1 if you like a punt. Might add to PM01 next week, even though the orids are massively shorted.

V8

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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303073

Postby johnhemming » April 25th, 2020, 6:27 am

The way I see it is that I would expect the government to aim to ensure that businesses that would have been viable without Covid-19 don't go bust. If they don't go bust then any money they owe will be an asset to the creditor. Most of their borrowings will be from banks.

GoSeigen
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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303082

Postby GoSeigen » April 25th, 2020, 8:13 am

ignotus20 wrote:My question is what is the situation with subordinated debt now if a bank gets into trouble? I know there are different clauses for each instrument (e.g. cumulative dividends for some, 4 for 3 in the case of NWBD etc) but I seem to recall the rules had been changed so bond holders could be bailed in more easily than during the banking crisis. So what is the true bail-in risk for subordinated bank debt and has the market underestimated it?


i doubt you're going to get a coherent answer to this. Not until you have highlighted what you think the problem actually is. So, which bank do you think may get into trouble and why?


GS

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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303178

Postby ursaminortaur » April 25th, 2020, 12:47 pm

88V8 wrote:
ignotus20 wrote:My question is what is the situation with subordinated debt now if a bank gets into trouble? .... what is the true bail-in risk for subordinated bank debt and has the market underestimated it?

On the plus side, the banks are much better capitalised than in 08.
On the minus side, indeed there is now a bail-in risk which on the whole there wasn't before.
On the get real side, the market has decided that the major banks are in no danger from this overblown blip and I agree, although we may see a prolonged pause in divis on the ords.

I hold most of the usual FI suspects, have sold nothing - you did well to sell in Feb - and have been adding.
If I were you I would be buying back so as not to waste your prescience.

That said, I try not to overstuff myself with Financials nowadays as there will eventually be another crash; already one sees the straws in the wind of reducing LTV requirements. So do not forget the non-bank BWRA and BP.B, and ELLA, and of course the Co-op is no longer a bank.

I've also been buying MBSP, PF21 and IPF2 although, yes, more Financials, hard to get away from them.

Then there's PM01 and ENQ1 if you like a punt. Might add to PM01 next week, even though the orids are massively shorted.

V8


The banks are now subject to a resolution regime which was instituted in the Banking Act 2009. If such a resolution were to occur then the BoE's preferred strategy fior larger institutions would be for all the existing ordinary and preference shares to be wiped out and the bond holders to become the new bank owners receiving ordinary shares for their bonds. For smaller institutions it is also possible that a take-over by another institution might be arranged or a modified form of insolvency might occur.


https://www.bankofengland.co.uk/financial-stability/resolution

After the financial crisis, the UK, like many other countries, took action so there would be better options if a large bank were to fail in future. The UK established a framework for resolution (known as the ‘resolution regime’) in the Banking Act 2009.
.
.
.
The three main strategies are:
Bail-in

This is our preferred strategy for the largest firms that provide vital services to the UK economy.

The firm’s equity is written off, and debts written down, to absorb losses. Then it is recapitalised – the debtholders whose debt was written down are issued equity and become the new shareholders. In the medium-term, it would be restructured to address the causes of failure and restore market confidence.

Transfer

Preferred for a medium-sized firm that could credibly have a buyer for all or part of it.

The firm is sold immediately or after a short period. If it takes a short period, then its critical functions are transferred to a temporary ‘bridge bank’ controlled by the Bank of England, before being sold on.

Modified insolvency

Preferred for a firm we think could be put into insolvency without risking our statutory objectives to protect financial stability and depositors.

The firm would enter into a form of insolvency. The FSCS would compensate eligible depositors up to £85,000, or fund a transfer of their accounts to a healthy firm.


If a bank were to get in trouble the canary would probably be the bailing in of the AT1/Coco bonds which were introduced as a class of instruments after the financial crash. These should convert well before the institution reaches the point of needing formal resolution since their conversion is tied to the capital level of the bank.

https://www.euromoney.com/article/b12kqjlwvsz26k/at1-capitalcoco-bonds-what-you-should-know


The buying of these instruments by retail investors was banned by the FCA in 2014.

https://www.fca.org.uk/news/press-releases/fca-restricts-distribution-cocos-retail-investors

As 88V8 says though it doesn't appear that Covid-19 threatens the banks particularly badly at the moment. The government is providing some support to businesses and their employees so as to lessen the impact of the lockdowns and for both political and economic reasons it is likely that those lockdowns will have to be eased in a few months time. Hence it is likely most businesses will survive this threat.

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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303190

Postby Tara » April 25th, 2020, 1:34 pm

“The banks are now subject to a resolution regime which was instituted in the Banking Act 2009. If such a resolution were to occur then the BoE's preferred strategy for larger institutions would be for all the existing ordinary and preference shares to be wiped out and the bond holders to become the new bank owners receiving ordinary shares for their bonds.”

So in such a situation then it is likely that NWBD, LLPC, etc. would be wiped out and bank preference shares would be worthless.

ursaminortaur
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Re: Preference Shares & Subordinated Bonds COVID Bail-In Risks

#303232

Postby ursaminortaur » April 25th, 2020, 5:28 pm

Tara wrote:“The banks are now subject to a resolution regime which was instituted in the Banking Act 2009. If such a resolution were to occur then the BoE's preferred strategy for larger institutions would be for all the existing ordinary and preference shares to be wiped out and the bond holders to become the new bank owners receiving ordinary shares for their bonds.”

So in such a situation then it is likely that NWBD, LLPC, etc. would be wiped out and bank preference shares would be worthless.


Yes - just as in an insolvency for a non-banking business any ordinary or preference shareholders would be wiped out.
The bank preference shares only survived the financial crash because after Lehmans the government found that the banks were too big to be allowed to fail or nationalise and hence the normal insolvency rules which would have wiped them out never came into play. The government have now with the resolution regime corrected that "problem".


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