Banks, AT1s and investors: Is this the start of a new financial crisis? 

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The, likely forced, takeover of globally system relevant Swiss bank Credit Suisse by its rival UBS on Sunday and a staggering CHF209bn (£184bn) package to avert an even bigger disaster bring back memories of 2008. Is this the start of yet another financial crisis? And do investors need to worry about additional tier 1 debt being written off? 
Swiss ministers, regulators and national bankers, along with a stony-faced chair of UBS and a sheepish-looking chair of CS, announced the takeover of the latter bank by the former for just CHF3bn after troubled CS had haemorrhaged customer deposits. The ‘private sector solution’ engineered by global finance ministers and central bankers came with a CHF9bn loss guarantee for UBS by the Swiss government and up to CHF200bn in liquidity from the Swiss National Bank, comprising of regular emergency liquidity assistance and a new liquidity backstop fast-tracked via emergency law. 

Is the capital structure intact?

“You can’t regulate trust and you can’t regulate away flaws in corporate culture,” Swiss finance minister Karin Keller-Sutter told the assembled financial press on Sunday, referring to the fact that CS had still fulfilled regulatory capital requirements but customers nonetheless chose to leave.
Whether trust has been helped by the fact these stunning measures were decided on Thursday but only announced on Sunday is one question. A bigger one will be what is happening to trust in markets if the holders of AT1 debt lose the entire value of their holdings, in the case of CS, a reported CHF16bn – finding themselves below shareholders in the capital structure.  
Given the uncertainty this wipe-out introduces for investors, the EU’s Single Resolution Board, the European Banking Authority and the European Central Bank have rushed to state that they would not follow the example of the Swiss. Instead, “common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down". 
The Bank of England pointed to the statutory order in which shareholders and creditors would bear losses in a resolution or insolvency scenario. AT1 instruments rank ahead of common equity tier 1 and behind tier 2 in the hierarchy. It also noted that AT1 investors in recently defunct Silicon Valley Bank UK saw their holdings wiped out – along with shareholders. 
“Holders of such instruments should expect to be exposed to losses in resolution or insolvency in the order of their positions in this hierarchy,” the Bank said. 
It added that “the UK banking system is well capitalised and funded, and remains safe and sound”. 
Similarly, US Treasury secretary Janet Yellen and Federal Reserve board chair Jerome Powell said that “the capital and liquidity positions of the US banking system are strong, and the US financial system is resilient". 

How ‘safe and sound’ are UK banks?  

The last big financial crisis was sparked by investment banks, and many will still have memories of the period which resulted in taxpayer bailouts – NatWest is still about 46% owned by the state – and in the UK, years of austerity with sluggish economic and wage growth, with all the social implications this brings. So is this another 2008?  
While central banks and governments are trying to tell investors that there is nothing to see here, on Sunday, the Bank of Canada, the Bank of England, the Bank of Japan, the ECB, the Fed and the SNB increased a standing US dollar liquidity line “to enhance the provision of US dollar liquidity”. The BoE said it has increased the frequency of 7-day maturity US dollar repos from weekly to daily.  
The announcement followed news that US banks drew record amounts from the Fed’s own emergency facilities last week, but on Monday, Bloomberg reported that the SNB has allotted $101m and the ECB just $5m via the new liquidity line, while the BoE and BoJ have not received any bids. 
Some say it is no coincidence that banks are once again in the eye of the storm. 
“Once markets sense that there have been and could be instances of regulatory failure and therefore cracks in the concrete block of regulation, things can quickly become very precarious for banks which depend inter alia very simply on the confidence depositors have of their sustainability,” finds Simon Willes, director of advisory IRM Models. “Bank liquidity can dry up faster than you can blink.” 
The unusually long period of historically low interest rates was always going to lead to problems, he adds, such as market jitters over the aggressive rate tightening by the Fed. The tightening means holders of government bonds, unless they hold them to maturity, could be facing considerable losses. 
Others remain relatively unfazed by the recent bank rescues in Switzerland and the US. Clive Gilchrist, a trustee executive at Bestrustees, believes the current turmoil will blow over.   
“Equities were too high anyway and looking for a reason to correct; when a correction comes, the proximate cause is often something unconnected,” he opined. 
CS – embroiled in money laundering and spying on employees among others – has been “a disaster waiting to happen for some time”, Gilchrist said.  
Compared with 2008, DB schemes are much less exposed to stock markets – the average allocation to equities went down from 59.5% in 2007 to 19.5% in 2022. However, if the next crisis affects bonds, this could come back to haunt pension funds. In the case of CS, holders of AT1 debt have seen their value wiped out as a clause permits not only the conversion to equities, but the zero-rating of AT1. 
“This is very unusual and is a dangerous precedent,” says Gilchrist. 

Unclear how the situation will evolve 

The market situation is fluid, and it is impossible to know if it will evolve into something bigger, finds Simeon Willis, chief investment officer at consultancy XPS Pensions Group. 
However, “what has become clear to me from the SVB situation is that the bank regulatory stress tests were not as effective as I would have expected in relation to spotting exposure to general interest rate risk,” he says. 
Compared with 2008, however, pension funds have much higher levels of liability hedging and are better funded, he points out. 
While AT1 debt is a specific type of financing, it will feature in some pension scheme portfolios within a specialist fixed income mandate, he says, but “it will not be a large core allocation and I doubt would affect most schemes”. 
Markets are volatile but for Willis, pension schemes are still well placed to make long term strategic decisions as the ‘rules of the game’ still hold, he says – unlike last September during the gilts crisis. 
Pension schemes are long-term arrangements, he adds; therefore, “if you’re not currently in a crisis, you know one will be coming sooner or later, as surely as day follows night. The key is to ensure that risk is managed within appropriate bounds and that you are clear what you are trying to achieve and how you are going to achieve it.” 
For those with liability-driven investments where Credit Suisse is a counterparty, there will be no disruption, says Willis. Even if CS had defaulted, “the implications for pension schemes in terms of losses would likely have been very modest given the extensive safeguards that are built into collateral arrangements”. 
Spence & Partners’ head of investment consulting Simon Cohen is relaxed about recent events. Banks are better capitalised than they were in 2008 and there is greater liquidity, he says, pointing out that on Monday markets “bounced back a little bit”. 
The write-off of AT1 debt holders is specific to Switzerland, he believes, where the emergency intervention allowed regulators to put shareholders first. 
There has however been some flight to safety driving down gilt yields recently which could have impacted funding levels for some underhedged schemes. 
For Cohen, the bigger news will be how central banks in the US and the UK act later this week, as the issues with US regional banks could make it harder for the Fed to pursue its tightening stance. 
Pension funds will have some exposure to AT1s as part of their portfolios, agrees Alistair Wilson, head of institutional business at TwentyFour Asset Management, which will depend on their mandates and managers. 
It will rarely be a standalone exposure but form a small part of their corporate bond allocation, he explains, and as such, it “will be entirely manageable”. 
This is not just another crisis, however; it is a symptom of a changed world, one where interest rates go higher and geopolitics is driving the agenda, resulting in febrile markets, says senior adviser at Avida International, Ian McKinlay. “A crisis is not a business continuity outage, it’s a shock, an unpredictable shock,” he says. Most pension funds are not prepared for such shocks, he warns – a situation made worse by resourcing problems in defined benefit schemes. 
Pension funds are still reliant on risk registers, he says. “They don’t have the muscle memory to deal with crises when they come along. They need to repoint and re-engineer not how they think about it, but how they respond to risk.” 
Will the storm in the banking sector blow over or is there more to come?

Clive Gilchrist
Simon Cohen
Ian McKinlay

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