Author: Tim Sharp
Researcher: Jack Williams
Published: March 22, 2023
Amidst the chaos in the banking sector this week, comes the destruction of Credit Suisse’s AT1 bonds, sending ripples through fixed income markets and causing hefty losses for bond giants such as Pimco who saw losses of $340 million on the banks AT1 product.
The deal between UBS and Credit Suisse leaves CoCo holders to bearing the losses while shareholders receive a small token with one share of UBS being exchanged for every 22.48 shares of Credit Suisse held.
Shown above is the WisdomTree AT1 CoCo bond UCITS ETF, which combines various AT1 products from across the banking universe to form a diversified ETF. Since the turn of the month, the funds value has fallen by nearly 12% and by more than 7.5% in the past 6 days alone showing the serious concerns of investors holding CoCo bonds, and investors uncertainty surrounding European banks in general. The fund now trades a mere 20 cents from the low it marked back in March 2020 when Coronavirus made its debut appearance.
AT1 bonds, otherwise known as CoCos (Contingent Convertible Bonds), have unique features dissimilar to other bonds investors may hold, they are issued by banks to raise capital. AT1 bonds are unique in the way they are designed to absorb losses in the event the issuing bank experiences financial distress. These bonds once again dissimilar to other bonds can be converted into equity or written off completely if certain conditions are met, such as falling CET1 ratios.
While CoCo’s tend to pay an exacerbated yields in comparison to other banking bonds, this is justified by being amongst the first few rungs of debt to be potentially restructured or written off when a bank comes into trouble such as we have seen with Credit Suisse in recent days.
While UBS has stepped in and made a deal for Credit Suisse, investors remain concerned about the wider banking market as seen by the huge declines in banking stocks across the EU, U.K and U.S. over the past week. Furthermore investors are now posing questions as to banks profitability after long swathes of time in low interest rate environments where deposits may have been hedged using fixed income securities now trading well below their waterline due to the rapid pace of interest rate increases employed by central banks around the world.
A mere month ago, financials was one of the most overcrowded, overweight sectors positioning wise. Now investors are reassessing the sector once again, having seen shares slide to the downside, this poses the question are the banks an opportunity at these levels, or something to avoid.
https://www.pimco.co.uk/en-gb/investments/gis/capital-securities-fund/inst-gbp-hedged-inc
https://www.ft.com/content/fcfaea32-7288-49f8-acb0-84c846b157d9
https://www.theguardian.com/business/2023/mar/20/at1-bank-bonds-credit-suisse-bondholders-cocos
Charts:
1st: Wisdomtree AT1 CoCo Bond Fund – LP68490358 1Yr Chart
2nd : PIMCO GIS Capital Securities Inst GBP Hgd Inc – LP68227330
3rd : Wisdomtree AT1 CoCo Bond Fund – LP68490358 3.5Yr Chart
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