The Market has no Memory when it comes to Bank Capital

It’s International Talk Like A Pirate Day, which will make it interesting for UBS trying to persuade once-bitten, twice-shy investors to buy new AT1 CoCo Bond after what happened to Credit Suisse investors.. “Arrr… You know it makes sense, young Jim-me-lad… Shiver-me-timbers… “

Blain’s Morning Porridge – 19th September 2024: The Market has no Memory when it comes to Bank Capital

“Heaven, you fool? Did you ever year of any pirates going thither? Give me hell, it’s a merrier place.”

It’s International Talk Like A Pirate Day, which will make it interesting for UBS trying to persuade once-bitten, twice-shy investors to buy new AT1 CoCo Bond after what happened to Credit Suisse investors.. “Arrr… You know it makes sense, young Jim-me-lad… Shiver-me-timbers… “

Today is International Talk Like a Pirate Day. Yay! Let’s get it all out there to start the day:

“Why are pirates, pirates?” “Because they Aaaarrrr…!”

“Belay that me hearties, slice the mainbrace, swab the deck, furl the jib, fettle the fuzzocks, and bring out the plank”.

“Better far to live and die under the brave black flag I fly!”

Etc, etc….

Of course, pirating was no easy thing. Most fed the crows from the gibbet, or were strung from a yardarm. Things could be even worse: “The pirate Yellowbeard captured many galleons. He would tear the captains hearts out and swallow them whole. He forced his victims to eat their own lips, but was caught and imprisoned for… tax evasion.”

Give a child a box of Lego and in minutes they will have built a multi-coloured Pirate Ship. There is not one amongst us who secretly doesn’t fancy the hat, the swish of the coat, the sword and an eye-patch. Who doesn’t want to find pirate treasure? Meet any disruptive tech baron, and at some point they will describe themselves as a Pirate. We had Pirate Radio and Pirate-Bay streaming. The most reliable and diligent yacht-owning tax-accountant will have a Skull and Crossbones neatly folded in his flag locker. (I know mine still does – even after he retired rich after “dealing” with HMRC for me….)

There is something deeply attractive about being a Pirate as opposed to working in the office. To understand more fully, I strongly suggest The Crimson Permanent Assurance, a short documentary, ahem, by acclaimed film maker Terry Gilliam illustrating the endless possibilities offered in the field of City Piracy.

There is something wonderfully piratey being a pirate. But I suspect the real pirates today remain the ones in positions of power, wealth and influence. I should like to be a Market Pirate – but it would just encourage some regulator to slap me down lest I upset the current system. Let me leave it to Gilbert and Sullivan:

I sink a few more ships, it’s true, than well-bred monarch ought to do;

But many a king on a first-class throne, if he wants to call his crown his own,

Must manage somehow to get through, more dirty work than ever I do.

 Back in the real world….

Exactly as predicted Oil hit and sped through $95 yesterday. And you are surprised? This is a case of bad is bad as stock markets tumbled, bonds wobbled and central banks checked their inflation prognostications. Inflation beaten? Nope. It stalks the land like a rogue office block. (Seriously, watch the Crimson Permanent Assurance!)

For the next couple of days markets will worry about what the Fed and Bank of England are going to do. Are they going to break the consensus expectation rate hikes are done? Is it time to think about when global centrals banks start to ease? That is a hope, not an expectation – it’s a hope that’s still underlying markets. Sustained energy cost push plus overinflated stock valuations is a recipe for correction.

What happens during a correction me hearties? (sorry, bit of piratese crept in there..) A couple of readers are concerned about banks.. Banks? That’s so 2008 – except its not. Rising commercial property problems, a housing crisis plunging home owners into negative equity and an outbreak of credit flue among corporates is hardly encouraging for banks.

Banks get that – they are all aware of Law No 1 in Bank Capital: Raise Capital When You Can, Not When You Need To! And for any bank to raise new capital ahead of a looming crisis, it has to look effortless. It doesn’t do to be looking desperate for new capital. In fact, when raising new bank capital, the most important thing to demonstrate is that you most definitely, definitely don’t need new capital.

Which is a problem for UBS.

Among the crazy things happening in markets is UBS seeking to issue new Additional Tier 1 “Coco” bonds to refinance bonds the market expects them to call over the next 5 months, and to recapitalise after the boarding and seizure acquisition of Credit Suisse. If it succeeds, and I am sure it will, this illustrate better than ever my market mantra: The Market Has No Memory.

Back in March, UBS “rescued” Credit Suisse in a deal of financial gymnastics whereby $17 bln of AT1 debt was written off, while leaving Shareholders “intact” but consider less whole than they were pre-crisis. It demonstrated the fundamental truth of the Contingent Capital AT1 market – these instruments have all the upside of bonds, and the downside of equity: meaning you will never get more than the coupon in returns and if it goes badly wrong you lose ahead of equity holders – putting AT1 holders in the deepest bilges of the subordination ladder.

Since the CS fiasco, a number of European banks have piled back into issuing new AT1 debt. These include such financial paragons as BBVA, BNP and Intesa. I would describe all these names (especially BBVA) as having a “pragmatic” approach to managing their liabilities – if push comes to shove, and there is further financial crisis they won’t bother with pleasing bond holders, but stick to the letter of the documentation regarding trigger and viability events meaning the holders are zeroed, or calls are ignored.

According to the FT UBS is trying to reassure potential investors in its new deal: i) they aren’t Credit Suisse, ii) the “Swiss Risk” that the Swiss Regulators is overly hostile to debt investors is overplayed, and iii) they are seeking to give investors greater clarity on what happens when it all goes wrong. Perhaps the best idea is that rather than wipe the bonds to zero, they should be converted to equity in the event off crisis, thus sharing the same risk as equity holders. That would confirm they are, in effect, just preferred bonds… but that raises tax implications for the banks.

There are some great lines in the FT article: UBS sounds out investors over first AT1 sale since Credit Suisse rescue that illustrate the conundrum the bank faces rather well:

  • “UBS is under pressure to replace up to $17bn of Credit Suisse AT1 bonds in the coming years to improve the efficiency of the enlarged bank’s capital structure and free up funds for shareholder returns and potential acquisitions.”


  • “UBS are working frantically in the background to sort this out,” said a bond fund manager who recently met the bank’s representatives. “They need to give investors confidence that the capital structure won’t be inverted and the rules won’t be changed at the eleventh hour again.”

From a headline return number, investing in AT1 bonds does look attractive. They offer a higher yield to account for their deeply subordinated risks… and, as any bank bond buyer will tell you: banks hardly ever go bust, (he says six months after Credit Suisse and 15 years after Lehman, and multiple US regionals earlier this years.) Whatever, if you like the name and like the yield be my guest.

Five Things To Read This Morning

WSJ                  The Fed Isn’t Getting the Economy It Expected

BBerg               Saudi Football League Draws Fewer Fans than Ryan Reynolds’ Wrexham

FT                     There is no work to balance: how shrinking budgets, Covid and AI are shaking up consulting

WSJ                  The Unexpected New Winners in the Global Energy War

Torygraph         As interest rates peak, how far and fast could they fall?

Out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital


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