Rob James
Premier Miton Financials Capital Securities Fund manager
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Credit Suisse
Our view was that Credit Suisse (CS) was solvent and liquid, and mainly had a profitability problem, which the new management team were addressing through actions to reduce the investment bank and focus more onto the high return wealth businesses.
Indeed, on Wednesday (15.03.2023), the Swiss regulators stated publicly that CS was solvent, liquid and meeting all the requirements of a GSIB (Globally Systemically Important Bank).
Our view therefore was that any problems with CS would be of a liquidity nature – i.e., deposit withdrawal – which could be covered by lines of credit from the central banks, which again on Wednesday (15.03.2023) were offered by Switzerland.
During Sunday, markets unusually were open, and on the announcement that UBS was buying the equity of CS, the AT1s traded up to as high as 60c, from levels of 20-30c earlier in the day. The expectation was that the hierarchy would be observed and AT1 would be whole.
Within the Swiss banking laws, AT1 can be written down without equity being involved under very specific conditions. Extraordinary Government Support is the required condition, and it seems that a new law was passed over the weekend classifying the liquidity assistance and guarantee as Extraordinary Government Support, thus allowing FINMA, the regulator, to enact the write down. In a normal resolution in Switzerland, the capital hierarchy is preserved.
Given that the problems appeared to be purely liquidity related rather than solvency related (i.e. CS had plenty of capital) this is a very surprising outcome to everyone.
The situation in the rest of the Europe and the UK is somewhat different. In Switzerland, the AT1 terms are contractual, whereas for banks under the Basel regime, the terms are written into statute, under the Banking Resolution and Recovery Directive, the BRRD. Under BRRD the Point of Non-Viability requires that all creditors are treated at least as well as they would have been in a standard liquidation, with AT1 ranking ahead of Equity in this case.
What this means is that equity shareholders must lose their investment before AT1 holders in the event of a non-viability event. If shareholders are not wiped out under such an event, then neither are AT1 holders for banks under BRRD.
Within the Premier Miton Financials Capital Securities Fund, some AT1s convert into equity at the CET1 trigger point, some are written down temporarily with the potential for future write up, and some are written down permanently. Our view has always been that this makes very little difference in reality. Once a bank got to the point that its contingent convertibles (cocos) were triggering, then the bank would have failed and, as above, its equity would be worthless, so there would be no real difference between the three outcomes.
Today (as at 19.03.2023) Bloomberg is also reporting that the EBA, SRB ( Single Resolution Board) and ECB are saying that AT1 remains an important component of capital. Obviously, shockwaves are flowing through the sector today, and prices will be sharply lower as investors reassess their positions, and presumably the required return on AT1 will be higher, at least for a period, than before. There will also be question marks over Swiss governance, as this deal was enacted with no shareholder vote.
A disappointing and indeed surprising outcome for a bank that only days before had received the thumbs up from its regulators. As you might have expected, markets were unsettled this morning but, as the dust has settled and the overall perception appears to be that this type of solution only applies to Switzerland, the situation has improved.
Outlook
Given the fundamental health of the system as a whole, as well as the names we own in the portfolio, we see this is as buying opportunity in the asset class as a whole. We believe CS is an isolated case, however the Swiss regulator’s extreme measures are likely to trigger weakness across the sector as a whole.
We see the likelihood of multiple write-downs as highly unlikely and think that this presents an opportunity for investors at current pricing.
