??? CoCo Pops! CS's vaporised AT1 bonds ?? Also: First Republic, Second Bailout? ?? The AT1 / CoCo bonds (wiped out at CS)

• US large-cap S&P 500 closed 0.89% UP ▲?
• Tech-heavy Nasdaq Composite closed 0.39% UP ▲?
• Pan European STOXX Europe 600 closed 0.98% UP ▲?
• HK's Hang Seng Index closed 2.65% DOWN ????
• Japan's Nikkei 225 closed 1.42% DOWN ????

?? Focus

• CoCo Pops! CS's vaporised AT1 bonds

?? In the Markets

• First Republic, Second Bailout?

?? MoneyFitt EXPLAINS

• ?? The AT1 / CoCo bonds (wiped out at CS)

?? Focus

CoCo Pops! Credit Suisse's vaporised AT1 bonds

The shotgun marriage (see yesterday's MFM) of a reluctant UBS to its even more reluctant Paradeplatz neighbour Credit Suisse resulted in mostly everyone involved with Credit Suisse other than short sellers feeling pretty unhappy. As one of just 30 globally systemically important banks (G-SIBs, otherwise known as "too big to fail" banks), something did have to be done to prevent Credit Suisse from going under.?

“The bankruptcy of a globally systemic bank would have caused irreparable economic turmoil in Switzerland and throughout the world” - Swiss finance minister Karin Keller-Sutter, after heading off what would have been a bigger bank failure than Lehman Bros.

?????? But among all the unhappy people none were unhappier than owners of something called Alternative Tier 1 capital (AT1) bonds, also known as Contingent Convertible (CoCo) bonds ??. In the takeover of Credit Suisse, the main Swiss regulator Finma said the deal would trigger a “complete writedown” of the value of all of the bank’s US$17 billion worth of AT1 bonds, i.e. the owners of the bonds would get nothing, while shareholders, who usually rank below bondholders in terms of who gets paid when a bank or company collapses, will receive $3.23bn in UBS shares. Typically, the first to get hit when a company gets into trouble would be the common equity shareholders, and only once they are wiped out would the pain be felt by various "layers" of lenders to the company (which includes bondholders) based on clearly spelled out levels of seniority. Globally this is a $275bn market.?

Chef Skinner reads the small print of his Credit Suisse AT1 bond documentation

- Image credit: Ratatouille / Pixar, Disney via Tenor

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?????? After the 2008 crisis, a new layer was introduced to provide an extra buffer of safety that sat in between conventional bond and equity holders. Or so most AT1 investors thought... This is why you gotta read the small print. Bond documentation shows Finma had the legal right to do exactly what it did, which triggered a panic on Monday among holders of AT1 bonds issued by other banks. Investors all knew the stuff they held was riskier (more "junior") than conventional bonds, which is why they managed to get a higher return (the yield, or rate of interest) on those AT1 bonds, in compensation for that higher risk. But if the risk was actually higher than they previously thought, the interest rate would also have to be higher, which means the bond's price would have to be lower (see mini-explainer below.) It also means that all issuers or reissuers of AT1 bonds would have to pay more to borrow money.

?????? So to calm the market rout on Monday, other European regulators said owners of AT1 debt would only take the hit AFTER all equity shareholders had been fully wiped out, UNLIKE what happened at Credit Suisse. The Bank of England said AT1 bonds rank before "the highest tier of equity capital", while the European Central Bank and the European Banking Authority said equity instruments would be the first to absorb losses. This helped calm markets a bit (the Invesco AT1 Capital Bond ETF in London fell 15% on Monday at the open before closing down 6%) but sentiment remains horrid, lawyers are sharpening their pencils, and the knock-on, unexpected and unintended consequences remain to be seen.?

Bond prices and yields - a mini-explainer

• Bonds are borrowings for a specified period from investors and are different from shares, which is a piece of the ownership and (usually) voting rights of a company.
• Bonds are also called "fixed income securities" meaning that each bond will pay out a certain number of dollars as interest payments, known as the "coupon", so the traded price of the bond will determine the interest rate of that bond (known as the yield).
• Remember this: When the price of the bond goes down, the yield (interest rate) of that bond goes up and vice versa (since yield = coupon / price.)

UBS boardmember, seen here greeting a passing Credit Suisse AT1 bondholder

- Image credit: It's Always Sunny in Philadelphia / 20th Television, Disney ABC via Tenor

?? In the Markets

Stocks in both Europe and the US closed higher on Monday as traders grew hopeful that the threat of a full-blown banking crisis may be easing, with the Sunday night end of Credit Suisse's 167-year history a done deal. So attention turned back to central bankers (sigh.)

?????? The FOMC, the rate-setting committee of the US central bank, will meet on Tuesday and Wednesday, with the announcement on the second day of its decision. Given the turmoil in the banking industry following the failures of SVB and Signature and First Republic's is-it-still-alive twitching, a pause is possible. However, it is generally expected to be a 0.25% hike, which would be milder than last week's 0.50% flex by the ECB, showing confidence in its banking sector despite turmoil in (non-Eurozone) Switzerland. The Bank of England (BoE) will hold its policy meeting on Thursday and the Monetary Policy Committee is expected to raise the Bank Rate by 0.25% to 4.25%, the highest level since 2008.

Also this week, TikTok CEO Shou Zi Chew will testify before Congress to face US lawmaker concerns that the social media app’s China-based parent company, ByteDance, could be compelled to comply with the Chinese government’s data surveillance practices. Earlier this month, Congress introduced the bipartisan Deterring America’s Technology Adversaries Act (DATA), which, if passed, could give the president authority to ban use of TikTok in the US entirely. (See last Friday's MFM focus story.)

?????? Critics of the efforts to ban the platform in the US note that all social media networks engage in pretty rampant collection of users’ data. Big Tech seems to be uncharacteristically reticent about commenting on the TikTok saga, perhaps because they want a fierce and disruptive competitor (wherever it's HQ-ed) hobbled or expelled altogether (we wonder which lobbyists have been "speaking" with which Congressman), or perhaps they are happy that the data and privacy (and corrosive, addictive influence on a generation of children) spotlight is concentrated on somebody else rather than on them as a(n American) group.

"But even if TikTok scoops up too much data, it’s no different from most apps out there, many of which are pretty greedy data gobblers." - Julia Angwin in the NYT

First Republic, Second Bailout?

While the share price of Credit Suisse dropped by a predictable 56% to CHF0.82 on Monday, to account for the forced rescue by UBS (which, after an initial drop of 14% ended just over 1% up), over in the US, shares of First Republic halved. Again. It closed down 47% less than a week after large US banks led by Bank of America, Citigroup, JPM and Wells Fargo pumped $30mn in uninsured (not really) deposits but failed to ease fears it will need a second (or actually a proper, full-on) rescue just to stay afloat.?

?????? JPM and/or the other banks are said to be in talks to buy some or all of it. The stock is down by 90% just this month alone, with a market value of $2.23bn. Showing that there are buyers out there at the right price, a deal was struck on Sunday for New York Community Bancorp to buy deposits and loans from the failed Signature Bank. This boosted sentiment in US banks... other than First Republic. New York Community Bancorp appears to have gotten a great deal, with shares surging 32% (and continuing to rise in aftermarket trading.)

?????? Meanwhile, ratings agency S&P Global downgraded the bonds of First Republic again on Sunday, pushing it deeper into high yield "junk", citing liquidity risks. It's the second downgrade in less than a week.

S&P Global, Moody's and Fitch... WHY... ARE... YOU... SLEEPING?

- Image credit: Finding Nemo / Pixar via Tenor

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Bond rating agencies - a mini-explainer

• Bond rating agencies are companies that evaluate the creditworthiness of bond issuers, indicating the risk of default, and all are regulated by the SEC.
• They use a scale to assign ratings to bonds, ranging from AAA (highest credit quality) to D (default). Investment grade bonds are typically rated "BBB-" or higher by S&P and Fitch and Baa3 or higher by Moody’s.
• Potential conflict of interest arises when the rating agency is paid by the bond issuer to evaluate their bonds, leading to a conflict between the need to provide accurate ratings and the desire to retain the issuer's business.

MoneyFitt EXPLAINS?

?? AT1 or CoCo bonds

• Because banks play a central role in an economy, regulators ensure their survivability as essential infrastructure by having enough capital in case something goes horribly wrong. After the 2008 GFC, an additional layer was created on top of shareholder capital that would count towards "Basel III" banking requirements to reduce the risk of taxpayers funding yet another bailout of stupid, greedy bankers.
• Alternative Tier 1 (AT1) bonds are contingent convertible (coco) bonds issued by banks. They can absorb losses by converting into equity OR being written down when the bank’s common equity tier 1 (CET1, mostly shareholder funds) falls below a certain percentage of its assets (mostly loans) OR when the bank is so badly run it reaches the point of non-viability (PONV).
• AT1 bonds have high yields but also high risks for investors, as they are subordinated, perpetual and subject to discretionary coupon payments. They can also be wiped out entirely in case of a bank failure or takeover. (After the 2023 UBS takeover of Credit Suisse, many regulators stressed that common equity shareholders will get wiped out before AT1 bondholders.)