Bank Contingent Capital & Coronavirus Contagion

When you purchase bank contingent capital, you may marry it for the foreseeable future. Coronavirus contagion is challenging this contractual relationship.

With an on-going global economic and cash flow contraction, we undertake a deep dive within this Smartkarma Original report to understand which banks are better equipped to keep their vows regarding bond coupons and calls.

As such, we perform fundamental analysis, from an Additional Tier 1 (AT1) investor’s perspective, on 15 of the largest US, UK, and Asia-headquartered banks. We also assess this fundamental positioning relative to some of the largest banks in the European Union. We present our top picks and pans and provide single security recommendations based on relative value analysis wherein we consider the likelihood of continued coupon payments. The resulting handbook guides the investor through detailed analytical constructs to deliver actionable recommendations.

The analysis is also driven by our view that a liquidity event is the Point of Non-Viability (PONV) for any financial institution. In the current operating environment of large forbearance activity, this coronavirus economy brings us closer to a liquidity event. We believe the market underappreciates this risk. As such, we go somewhat ‘mad scientist’ in considering the deposit franchise strength and cash flow composition of each banks’ liquidity towards assessing sensitivity to a payment flow contraction. This is original analysis.

With the recent passage of time and expectations of better days ahead, AT1 bond prices have recovered slightly. We are not convinced that this recovery is sustainable since much depends on the pathology of this disease. As such, we cannot rule out eventual vow renunciations via AT1 coupon suspensions, non-calls or a death do us part PONV event for certain institutions.