Tuesday 25 February 2014 by Elizabeth Moran Opinion

Credit Suisse calls Tier 1 hybrid early

Elizabeth Moran assesses the Credit Suisse Tier 1 hybrid early call and  highlights considerations if you hold Tier 1 hybrids  currently trading at a premium.

Key points:

  1. Credit Suisse is one of the first European banks to exercise an early call on its Tier 1 hybrids that were trading at a premium.
  2. European banks have been reluctant to call these securities early unlike US and Asian banks.
  3. Consider your individual circumstances and the impact an early call would have on your return. It may be better to sell some or all of the securities to lock in the premium depending on the proximity to call and the cost of funding to the financial institution.

The Credit Suisse story

Credit Suisse (CS) has announced they are calling their Tier 1 7.875% Claudius notes before the first call date in December 2015, citing a change in regulation as the reason for the early call. CS has plenty of capital and comfortably meet all Basel III and Swiss regulatory requirements, and as these notes are expensive, have opted to call the notes early. While they are within rights to redeem early due to the regulatory change at par ($100), they have offered to buy-back the notes from investors at a premium of $103 to compensate for loss of value as the notes were recently trading as high as $107. However, if investors do not accept the buy-back offer, the notes will be called before December 2015 at $100, losing the premium offered and well below the recent trading price of $107.

The Regulation

The majority of Tier 1 hybrids (and subordinated debt) contain clauses that allow the issuer to redeem early under certain conditions, notably a change in regulation, taxation, credit rating or ownership. New Basel III rules and their impact on regulatory capital calculations give the banks ground to call early if they wish, although the wording around an early call is fairly lose and depending on the age of the hybrids varies significantly between issuers and the respective domiciles. The situation for insurance companies is less transparent given slower regulatory reform post-GFC, remembering Basel III is only for banks, nonetheless the risk of regulatory early call is also present for insurance regulatory capital securities.

Evidence suggests that US and Asian banks are comfortable invoking early redemption but European banks are wary about causing any damage to important institutional relationships. Australian banks have similar clauses but have not invoked an early regulatory call to our knowledge and are viewed as unlikely to do so.

Considerations for investors in Tier 1s

Just this week I was asked to review a Barclays and a HSBC Tier 1 for possible early conversion. The prospectuses varied considerably, but key points for investors to consider include:

  • What is the domicile of the issuer? European banks seem less likely to call early
  • Is the hybrid trading above par? Those below par should not be concerned; an early call at $100 would be a benefit
  • What is the coupon being paid on the notes? Most European banks could replace Tier 1 securities with new Basel III compliant (CoCo) securities at a cost of around 7% in the current market. A very high coupon would be attractive to redeem early where possible for issuers as it reduces the cost of funding
  • The time until first call. The longer the bank must pay a higher than market coupon, the greater the chance of an early call. All bonds and hybrids will start moving towards par 18 months to a year prior to maturity
  • Does the issuer have a fixed and floating line of the same security? Typically an issuer would have to call both issues and if one is trading at a premium (in the current environment this would generally be the fixed rate security and would be viewed as expensive for the issuer) and the other at a discount (generally the FRN which may be cheap funding for the issuer), the net impact of both would need to be assessed
  • And possibly the greatest consideration is the reputation of the issuer. In particular, issuers are less likely to do something to upset institutional investors, particularly if the security was sold with the intention it would behave in a certain manner, typically would run to first call date and be redeemed at par on that date. In Europe at least, there is strong evidence that issuers are far more likely to call (or not call) a security to the detriment of investors if it was sold to the retail market as opposed to the wholesale/professional market on which they rely for future funding

The terms and conditions for each Tier 1 hybrid are different; there are no hard and fast rules in terms of possible conversion. Australian dollar Tier 1s trading above par are the fixed rate Swiss Re May 2017 that can be sold at circa $104.50, the AXA October 2016with at circa $103.50 and the Rabobank December 2014 at circa $100.90 with many more trading at a premium in foreign currencies. If you hold a foreign currency Tier 1 hybrid and are concerned about the repercussions of an early call, please call your dealer.

As a generalisation (and there will be exceptions), callable securities are best purchased at a discount and sold at a premium, as they will only ever be redeemed at par, be it as expected at first call date, a subsequent call date or in unusual circumstances (such as a regulatory change) at an earlier date than expected.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. Swiss Re, AXA and Rabobank Tier 1 hybrid securities are only available to wholesale investors.

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