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.
- 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.
- European banks have been reluctant to call these securities early unlike US and Asian banks.
- 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 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.
The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.
No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.
FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.
An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.