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Tier 1 capital: Difference between revisions
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And we should not feel undue sympathy for distressed — ahem vultures — looking to buy a 7% fixed instrument for cents on the dollar when the issuer is in the midst of a well telegraphed existential meltdown? ''We should not''. Even if the ones who ''did'' read the prospectus. | And we should not feel undue sympathy for distressed — ahem vultures — looking to buy a 7% fixed instrument for cents on the dollar when the issuer is in the midst of a well telegraphed existential meltdown? ''We should not''. Even if the ones who ''did'' read the prospectus. | ||
One invests in common equity to take advantage of rapidly changing market conditions. An equity price is a capricious, will o’ the wisp sort of thing that flits about impishly, by driven by the unpredictable humours of the market. One can, and many do do make a living trading short-term movements. | |||
In ordinary times, interest-bearing notes — when AT1s — are much less volatile than common equity. Their market value will not fluctuate much day by day. Their main attraction is their coupon yield. You only benefit from that over time. AT1s reward long-term investment. In ordinary times their return is a linear function of ''how long '' you are prepared to hold them, and therefore how long you fund the bank’s tier 1 capital. | |||
Itvis different in a bank distress scenario. Here AT1s are unusually vulnerable: this is the very contingency they are designed to protect ''the bank'' against. As the banks capital ratio approaches criticality, their performance more and more to resembles the equity. | |||
''Convertible'' AT1s which, in the worst case, will turn into common equity, will converge on the common equity exactly. | |||
''Write-Down'' AT1s will become even ''more'' volatile than common equity. They are, effectively, binary options: either they are triggered, in which case they are worth zero, or they are not, in which case they recover, will eventually be called at 100, and in the meantime will continue to pay fat slugs of interest. | |||
Indeed, this is exactly what we saw. | |||
Should we feel bad that speculators looking for a quick buck, who held the notes for a couple of days, got hosed? No. This is exactly the bet they were taking. | |||
Should we feel bad for buy and hold investors who held from issue and were written down to zero? No. They did much better than common equity holders over that period. | |||
The tier one capital layer is there to protect depositors and vouchsafe the stability of the wider financial system, whose collected interests are best served by the bank remaining a going concern. That they happen to share that interest with the banks ordinary shareholders is beside the point. The bonds reward long-term investors — those who read the terms and clocked that “Perpetual Tier 1 Contingent Write-Down Capital Notes” meant these were notes that could be written down in a time of capital stress — most likely had a bank to sell last week. | The tier one capital layer is there to protect depositors and vouchsafe the stability of the wider financial system, whose collected interests are best served by the bank remaining a going concern. That they happen to share that interest with the banks ordinary shareholders is beside the point. The bonds reward long-term investors — those who read the terms and clocked that “Perpetual Tier 1 Contingent Write-Down Capital Notes” meant these were notes that could be written down in a time of capital stress — most likely had a bank to sell last week. | ||