OldBoyReturns wrote:Interesting analysis although I don't think we are at a point where all credit of a FI can be said to carry nearly the same risk on the basis that regulators will bail it all in if they need to intervene. While, as you say, situations where discretionary coupon suspension alone are unlikely (although not implausible) regulators will generally respect the hierarchy so the bottom end, such as AT1 and prefs, will be more at risk than T2 and senior. The recent CS example is a case in point with AT1 being bailed in. I think that now regulators have a bigger toolbox and better gauges they can (and will) intervene earlier to stabilise a FI using combination of bail-in and market solution. This, together with higher levels of high quality capital, means credit higher up the stack is significantly less likely to be touched than the more junior stuff.
I wasn't suggesting that all credit of a FI now carries nearly the same risk - my comments were specific to "must-pay" prefs (I count the likes of NWBD in that camp, as they are discretionary on paper but have strong penalties for any dividend skipping) vs discretionary prefs (with no such penalty, like LLPC/D), not a general comment of senior vs sub, or the entire liability structure of a bank - I should have clarified.
Another aspect here is that since bank legacy sub instruments have lost their recognition as regulatory capital under Basel 3 rules/PRA implementation, they are now actually more vulnerable for a potential bail in (in a going concern scenario) via statuatory powers. When they counted as regulatory capital, bailing them in (=writing them off) made no sense in a going concern scenario, as existing capital cannot create any new capital - it's already capital. That's different now, where they are accounted for as non-CET1, which means that bailing them in actually creates new regulatory capital, so they've now become a prime target for supervisory bail-in action, well before the rest of the stack (depends how the legacy paper is accounted for - the above assumes it's now accounted for as a liability, not equity). That's probably overinterpreting the role of sub debt & prefs, and it doesn't scare me away from them, but any exit via a nicely priced tender removes this risk. And of course you can have outcomes like CS, which wasn't a bail-in via statuatory powers but an exercise of contractual triggers in AT1s - nothing was bailed-in by the supervisor, they only provided the trigger event for the AT1 terms to take its course, without changing the existing terms of any instruments and without writing anything off via statuatory powers. Some AT1 investors disagree on the declaration of the trigger event, but that's a question of how the terms should be read, not about the supervisory overriding thereof.
Still happy with the FI sub/pref universe but some of the spreads over gilts have rallied to such a ridiculous level that I've been taking chips off the table, switching into gilts. My largest position used to be NATW & NATN - still a mystery to me how Natwest treasury management, a year ago, could justify to its shareholders the exercise of the make-whole call at gilts flat and redeem the bond early, allowing me to switch out of an illiquid bank sub bond (with option to convert into prefs) into UK gilts without giving up a single basis point of yield. It cost them around £45mm as a hit to P&L. Noone can tell me that servicing/maintaining the bond issue until 2052, even if it's just recognised as simple debt funding, costs more than a few £100k. And it strikes me that im contrast, tenders for NWBD have been at poor levels in the past. Make-whole call and tender are obviously different animals (the call got rid of the entire issuance at once), but tenders can be structured efficiently to arrive at a similar outcome (hats off to the BOI tender+redemption structure, which also retired the entire bond issue, but much cheaper for the issuer).