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Tier 1 capital: Difference between revisions
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Less pedantic types feel that since you have to monitor that difference every day, and do something, like issuing more tier 1 capital securities, if it isn’t there, this isn’t really a distinction worth getting het up about. | Less pedantic types feel that since you have to monitor that difference every day, and do something, like issuing more tier 1 capital securities, if it isn’t there, this isn’t really a distinction worth getting het up about. | ||
But that pedantic distinction can be important, as we will see. | |||
Now: what are “tier 1 capital securities,” then? | |||
==Tier 1 common equity== | ==Tier 1 common equity== | ||
The classic tier 1 capital is | The classic type of tier 1 capital is an institution’s [[Equity securities|ordinary share capital]]. This is known, by the same people who know coronavirus as “[[COVID-19]]”, as “[[tier 1 common equity]]”, or “[[CET1]]”. | ||
Until 2008, that is all there really was. | |||
Then the [[global financial crisis]] happened, and the global community of bank regulators and their assorted committees, councils and forums got together, promulgated a largely coordinated set of bank resolution and recovery regimes, in the process savagely increasing tier one capital requirements with which banks had to comply. | |||
==[[Alternative tier 1 capital]]== | ==[[Alternative tier 1 capital]]== | ||
When banks complained about this — equity capital is quite the drag on performance — | When banks complained about this — equity capital is quite the drag on performance — regulators conceded there could be a layer of tier 1 capital which wasn’t ''actually'' common equity, but could be made to ''behave'' like it, should a bank’s chips ever got really down. | ||
On the good days, this layer could behave a lot like debt: it could pay fixed [[Coupon|coupons]], and redeem — ''if'' it redeemed — at par. Everyone concluded that since they had fixed the systemic problems, the prospect of lots of banks’ chips getting really down again at once was pretty low, so as long as banks created these new capital instruments, how they would work at the sharp end was mostly academic. | |||
That was 2008. Now it is March 2023 and here we all are. | |||
Anyway, this new layer of “quasi common equity” came to be known as [[alternative tier 1 capital|“alternative” tier 1 capital]], or “[[AT1]]” which, when said aloud, sounds like “[[eighty-one]]”. | Anyway, this new layer of “quasi common equity” came to be known as [[alternative tier 1 capital|“alternative” tier 1 capital]], or “[[AT1]]” which, when said aloud, sounds like “[[eighty-one]]”. People got excite4d about it. Our favourite [[Credit Suisse|lucky pooch]] even asked, in a thought piece in 2021, “contingent convertible bonds — better than bank equity?”<ref>[https://www.credit-suisse.com/lu/en/articles/asset-management/contingent-convertible-bonds-lu-202101.html See here.] Joking aside, the answer remains, “other than for distressed speculators, ''yes''”. In any case, they are talking about contingent convertibles, not write-down notes.</ref> | ||
AT1 capital takes the form of [[Interest|interest-bearing]] [[subordinated]] debt which the bank may, but need not, call after a few years, As such, from an investor’s perspective, it is ''perpetual'' in the same way ordinary shares are. But banks can decide to repay it, at par, if they like. This they will only do if times are good and it is cheap to issue more AT1 capital. | AT1 capital takes the form of [[Interest|interest-bearing]] [[subordinated]] debt which the bank may, but need not, call after a few years, As such, from an investor’s perspective, it is ''perpetual'' in the same way ordinary shares are. But banks can decide to repay it, at par, if they like. This they will only do if times are good and it is cheap to issue more AT1 capital. | ||
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Wounded AT1 holders were fortified in their dudgeon by other central bankers (BOE, ECB, the Fed) unhelpfully chipping in, saying, for the record, that that is not how ''they'' would expect to treat [[AT1]]<nowiki/>s. You can just imagine FINMA honchos going, “yeah, thanks, Pal,” when a central banker from ''Greece'' — yes, yes, ''that'' Greece — remarked “well, needless to say we’d never do anything like that. We Greeks are civilised, not like the Swiss!”<ref>This is a paraphrase, and an exaggeration for effect, I freely admit. [[https://www.cnbc.com/video/2023/03/20/awe-are-close-to-the-end-of-the-tightening-cyclea-bank-of-greece-governor-says.html?&qsearchterm=stournaras Full interview here.]</ref> | Wounded AT1 holders were fortified in their dudgeon by other central bankers (BOE, ECB, the Fed) unhelpfully chipping in, saying, for the record, that that is not how ''they'' would expect to treat [[AT1]]<nowiki/>s. You can just imagine FINMA honchos going, “yeah, thanks, Pal,” when a central banker from ''Greece'' — yes, yes, ''that'' Greece — remarked “well, needless to say we’d never do anything like that. We Greeks are civilised, not like the Swiss!”<ref>This is a paraphrase, and an exaggeration for effect, I freely admit. [[https://www.cnbc.com/video/2023/03/20/awe-are-close-to-the-end-of-the-tightening-cyclea-bank-of-greece-governor-says.html?&qsearchterm=stournaras Full interview here.]</ref> | ||
Now ambulance chasing [[Litigation lawyer|litigator]]<nowiki/>s are whipping up even more foment, indelicately trawling [[LinkedIn]] to raise a pitchfork mob of aggrieved investors to go and sue — well, it isn’t clear ''who'' they would sue, or for what, since this was done by legislation — and even the normally mild-mannered financial analyst commentariat has been periodically erupting into virtual fist-fights about what the [[AT1]]<nowiki/>s do or do not say and whether a trigger event did or did not happen. | Now ambulance chasing [[Litigation lawyer|litigator]]<nowiki/>s are whipping up even more foment, indelicately trawling [[LinkedIn]] to raise a pitchfork mob of aggrieved investors to go and sue — well, it isn’t clear ''who'' they would sue, or for what, since this was done by legislation — and even the normally mild-mannered financial analyst commentariat has been periodically erupting into virtual fist-fights about what the [[AT1]]<nowiki/>s do or do not say and whether a trigger event did or did not happen. | ||
Meanwhile, from the investors, there is lots of jilted lover energy: “how could I ever trust a central banker again?” sort of thing, and lots of “who knew Switzerland was a banana republic?” vibes, too. | Meanwhile, from the investors, there is lots of jilted lover energy: “how could I ever trust a central banker again?” sort of thing, and lots of “who knew Switzerland was a banana republic?” vibes, too. | ||
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But is that really true? | But is that really true? | ||
{{Image|Coco performance|jpg|From the pooch’s mouth: cocos really are better than equity. Over time.}} | |||
The panel above illustrates our best guess of the cumulative shareholder return — the diminishing cash dividends paid plus ongoing share price, which was in of course in insistent decline over 5 years — compared with the cumulative AT1 return, which are those much fatter, fixed coupons plus the AT1s’ market value, which we just made up, on the premise that until things got truly dire, it would have been somewhere near par. they were vaporised. | The panel above illustrates our best guess of the cumulative shareholder return — the diminishing cash dividends paid plus ongoing share price, which was in of course in insistent decline over 5 years — compared with the cumulative AT1 return, which are those much fatter, fixed coupons plus the AT1s’ market value, which we just made up, on the premise that until things got truly dire, it would have been somewhere near par. they were vaporised. | ||