ReSolve Riffs on Swiss Banking and Capital Structure Debacle with Brian Moriarty and Dave Nadig

In this episode, the ReSolve team is joined by Brian Moriarty, Associate Director of Fixed Income at Morningstar Research Services, and Dave Nadig, Chief Futurist at VettaFi Financial, to discuss the recent demise of Credit Suisse and the complexities of capital structure in banks. They explore various topics, including: 

  • The persistent overweight of fixed-income mutual funds in financials, and in particular, banks
  • The impact of the 2008 global financial crisis on the capital structure of banks and the regulations put in place
  • The fertile hunting ground for active managers in the complex capital structure of banks
  • The Credit Suisse trade setup and its implications for fixed-income portfolios
  • A comparison of capital structures between regulated banks and traditional US corporates
  • The unique contractual clauses and outcomes of European and US preferred shares, specifically contingent convertible bonds (Cocos) and Tier 1 capital (AT1)
  • The nuances between Swiss and other European banks’ AT1 and regulatory requirements
  • The performance of the capital structure regulations since the global financial crisis
  • The importance of understanding the risks and nuances within different levels of the capital structure
  • The role of bank counterparties and the potential risks they pose to the stability of financial institutions 

This episode is a must-listen for anyone interested in banking, capital structure, and the intricacies of fixed-income investing, providing valuable insights and strategies to navigate the uncertain financial landscape and better understand the complexities of banking institutions. 

This is “ReSolve Riffs” – live on YouTube every Friday afternoon to debate the most relevant investment topics of the day, hosted by Adam Butler, Mike Philbrick and Rodrigo Gordillo of ReSolve Global* and Richard Laterman of ReSolve Asset Management Inc.

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Brian Moriarty
Associate Director, Fixed-Income Strategies, Manager Research, Morningstar

Brian Moriarty is an associate director, fixed income strategies, for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He covers fixed-income strategies.

Before assuming his current role in 2015, Moriarty was a client solutions consultant for Morningstar Office, a practice and portfolio management system for independent financial advisors. Before joining Morningstar in 2013, he was a research assistant for DePaul University’s religious studies department.

Moriarty holds a bachelor’s degree in political science from Michigan State University and a bachelor’s degree in Islamic world studies from DePaul University.

Dave Nadig
Financial Futurist of VettaFi

ETF industry pioneer Dave Nadig is the Financial Futurist for ETF Trends and ETF Database. Nadig comes with 25 years of ETF experience, most recently as Managing Director of ETF.com, where he helped grow the business and provide expert commentary for the past decade. Before that, he managed mutual funds at startup MetaMarkets.com, and was a Managing Director at Barclays Global Investors in the 1990s.

He’s widely leveraged by media and institutions as a key expert in the field. Dave has been involved in researching, reporting and analyzing the investment management industry for more than 20 years, and recently co-authored a definitive book on ETFs, “A Comprehensive Guide To Exchange-Traded Funds,” for the CFA Institute.

TRANSCRIPT

Adam: 02:09

So today we’ve got Brian Moriarty, who is head of Fixed Income Research at Morningstar Research. And we’ve also got Dave Nadig, who is Chief Futurist at Vettifi Financial. Futurist at Vettifi. So we’re going to rock and roll today.

Mike, I guess you’d better do your usual, oh, everything is advice.

Mike: 02:33

No, wait, that’s right, nothing’s advice. Wide ranging conversation. Going to have some fun. Hey, we had the demise of a monstrous financial institution in Europe. This is not a small thing, just a pooh. Vanished. And now we get to get into layer cake. And nothing gets me more excited than a little bit of the stack of capital and understanding who gets what when shit goes wrong.

That is what I’m the most excited, because it’s never what you quite expect, right? It’s never quite what you expect. And so when I heard Brian and Dave, the three of us were chatting, usually Adam would have been there, but about the sort of the stuff that you were running across in this demise of Credit Suisse, man, it’s fascinating to me. So we thought we’d get you on here and have a good chat about it. So, by the way, none of this is advice in any way, will we be held accountable for its accuracy? So with that…

Backgrounder

Adam: 03:34

I haven’t even been accurate about poor Brian’s title, right? Just because I know he’s going to get in trouble. It’s Associate Director of Fixed Income at Morningstar Research Services, for the record. Now, Brian, with that said, why don’t you go ahead and give a little bit more detail about your role at Morningstar Research Services and why you happen to be particularly well suited to talk to us today about what happened last week with Credit Suisse?

Brian: 04:00

Sure, yeah. So as noted, I’m Associate Director of Fixed Income, Manager Research, at Morningstar Research Services and so I cover, monitor, rate, public fixed income funds, Metropolitan West, Total Return Bond, um, PIMCO, Total Return, not my coverage, but this is what we, the people we interact with, the funds that we’re covering and rating.
And so I spend most of my time in the weeds on the portfolio construction and decision making of public fixed income mutual funds. And the genesis of this conversation really started at the end of last year when I noticed that Credit Suisse was showing up as an overweight trade in a number of public fixed income portfolios.

But to get to there, and what happened in the last two weeks, we kind of have to start big picture. We’ll start at 2008 and then funnel our way down to the current time period. And I’ll move through this pretty quickly at this beginning part, so we can spend most of the conversation on the really interesting stuff that happened in the last few weeks.

But just to start, one thing that we’ve observed for a long time is that core and core plus mutual funds, fixed income mutual funds, are pretty consistently overweight to financials. And a big reason for that, and relative to the aggregate index, and a big reason for that comes out of 2008. Dodd/Frank, the Basel III accords. Right? This was the financial regulators’ response to the global financial crisis was, to put a lot of regulations in place on banks. And part of those regulations require banks, at least the regulated ones, the GSIBs, globally systemically important banks, to issue an extremely full capital structure. Equity preferred’s, all sorts of subordinated seniors, unsecured, and they have to have a certain amount of capital issued, to fulfill their regulatory requirements.

And that makes them pretty unique compared to a traditional US corporate. And when we get to it, I can sort of put up a very simple example of the differences between a couple of different cap structures. But because of how full a bank’s cap structure is, that’s one of the reasons why we tend to see them as an overweight in actively managed public fixed income funds, because there’s just so much there for an asset manager to pick between and pick from and play different parts of the capital structure, that aren’t always there for, let’s say, a high yield company that might only have one high yield bond outstanding for, let’s say, four or five, $7 billion compared to a massive cap structure, JPMorgan or Credit Suisse. So from an active manager’s perspective, it’s viewed as a very fertile hunting ground. More ideas, more opportunities. Whether that’s actually true or not, sort of X post returns, I’m not sure. But that has been the approach to that market.

At the same time, because of the size of this market, asset managers themselves of a certain size, almost have to participate. In this market, trhat includes banks overall, as well as the $270,000,000,000 AT1 market that we’ll talk about later. And finally, the belief that banks and financial companies will do well in a rising rate environment, which we’ve seen in the last few years, obviously, because net interest margin expands. Right. The interest that these banks can collect on new loans is higher than what they have to pay out on a deposit rate. We’ve seen that become a big topic of conversation in the last few weeks. And so that’s sort of the thesis that has been cited to us recently over the last year or two as the reason for the overweight.

However, I do want to point out again, this is a pretty persistent overweight, so it can change in size, but it’s not like asset managers are going way underweight and then way overweight. This is pretty persistent, I think, because of the overall size of this market and the fact that asset managers tend to be biased towards corporates in general relative to the AG.

So that’s the initial setup. From there, I can move into the Credit Suisse trade set up, or we can stop and take a look at…

Go back to why you were particularly motivated to dig into this, or maybe why you’ve got a particular expertise here, right?  Because you’re analyzing the decision making and the holdings at actively managed fixed income funds. And so it behooves you, therefore, to get expertise in the complexities of the capital structure of these banks, since it’s fertile ground for active managers to pick away at that capital structure. Because it’s complex, it’s hard to analyze, it requires more expertise, and therefore, in theory, it presents more opportunities for active alpha. Okay, that makes sense. I also think it makes sense for us to kind of this probably is where you’re going next.

But, um, would you say that the the capital structure of banks got substantially more complicated after the 2008 global financial crisis?

Brian: 09:48

Yes, they did. I think that makes sense to throw up an example here, just to make it easier to talk about. It’s not very easy to imagine the capital structure unless you do it a lot. So let me put this…

Dave: 10:02

Brian, while you’re grabbing the chart. You talked about this being an overweight. Like, how much of an overweight? Are we talking about portfolios, where this is 10%, Credit Suisse exposure is 10% of a portfolio, or are we talking between ten basis points and a percent kind of thing?

Brian: 1023

No, actually, I had a chart for that and I thought it would be too boring to look at because it’s just numbers, but, the overweight tends to be between one and a half and four percentage points. At least, I only look back through the beginning of 2018. I can do it further. I will do it further as my work on this progresses. But it was at the average, so I took the average of core and core plus mutual funds, combined them into one because they’re typically all benchmarked to the AG, and the AG’s allocation to financials is typically around seven to 8%. So one and a half to four percentage points higher than that, on average. In some cases, it can be significantly higher than the AG.

So you’ll have to forgive my, this is obviously a very simple, just Excel spreadsheet that I was putting together for my own benefit before this all started. And I want to be clear, this is very simplified, even from what it is in reality, but it’s enough to sort of make sense of it.

So I got three different banking regimes on the left and then a traditional US corporate on the right. Regulated banks are all required to issue equity, common equity tier one, at the very bottom. Above that is the preferred or AT1 market. Now in the US, they’re preferred shares, in Europe, they’re AT1s, and there are differences between them. They fill the same role in the capital structure and they both end up in preferred indexes, preferred funds, et cetera. They’re very similar. But there are some important differences which we can flip to in a minute.

And then above that is sort of tier two or subordinated debt, and then senior unsecured seniors, and then deposits above that. You’ve also got the holding company versus operating company, Opco distinction, right? So typically Opco debt is senior to hold co debt. That isn’t always the case in the UK. It’s sort of flipped for some reason, I don’t know why that is, at least at the bottom. And this sort of collapsed a lot of like I said, this has collapsed with some of the nuance. For example, the counterparties to these banks, which is a very important point because I think with Credit Suisse and also with Lehman, way back when, sort of their death knell was when their counterparties decided, hey, it’s too much of a risk to do business with you. That’s really the last gasp of any bank, in my opinion. Those exist, those claims, counterparty claims exist at the Opco senior level. So right below deposits, right?

Brian, I think I’m right that when most people talk about some of the derivative products that get run out of these balance sheets, like things like structured products or in my world, the exchange traded note or exchange rated loan market, my understanding is most of that’s coming in at the senior unsecured level. Certainly at Credit Suisse, I think almost all of it came in at that hold co senior unsecured level. So you’re well out of the danger zone if you’re buying some of those sort of more structured products, right?

Brian: 13:42

Correct, yes. The real risk is obviously at the equity level and then the preferreds and subordinated. So those are obviously considered sort of the first to go. A bail-in bond, by the way, this is the term that has also gotten thrown out along with AT1. A bail-in is a bit of a broader definition.

So there’s regulatory capital, which is what is required. They’re required to issue it to maintain certain capital ratios. And it’s the stuff that can be written or triggered down to zero or converted into equity. And that’s the bottom levels, the tier two or subordinated, and then the tier one AT1s, that’s the regulatory capital. And then a bail-in bond is stuff above that, the seniors unsecured, and sometimes even the seniors, the opco seniors.

A bail in bond is where the asset, excuse me, the bank can say, you know what, we are choosing ourselves to write this down to zero, to help avoid a bail-out. So theoretically, all of this, except for deposits, is at risk. But in practice, this structure has worked quite well. Before Credit Suisse, there was only one instance of an AT1 being written down to zero. That was Banco Popular in Spain, in 2017. So this has worked quite well since the financial crisis.

Adam: 15:16

Brian, I remember back in the financial crisis and then again in 2013, that there was another class of bonds that the banks issued called Coco bonds. Is that relevant here at all?

Brian: 15:30

Yeah, very much so. A Coco is an AT1. So all Cocos are AT1s. That’s contingent convertible, but not all AT1s are Cocos. And. And so actually, I’ll flip to this sort of tier one comp. Let me see. Okay, so this is a comparison between a Euro AT1 and a US preferred. So they fill, like I said, very similar roles. The same position in the cap structure. They’re both perpetual preferreds, callable after five to ten years, the same, typically the same credit rating, but the bottom three rows are where you get into the differences, and specifically as it relates to Cocos. And then we can talk about the rest of this. An AT1, a European AT1, can have three different types of outcomes, if its clauses are triggered, its contractual clauses are triggered.

So if the bank’s capital ratios fall below a certain level, it’s typically 5% for what’s called a low trigger Coco, or at one, and then seven and a half percent for the higher trigger. If it falls below this trigger, then there’s one of three, outcomes depending on the contracts, in the AT1 perspectives. The first and most common is that it’s converted into equity. That’s where the Coco comes from, contingent convertible, contingent on the clause has been triggered. And now obviously, or at least we would expect, that would only happen after the equity has gone to zero and then it’s converted into new equity.

The second type is a temporary write down, meaning it’s written down to zero or partial loss, depends on the regulator. and the clauses to bring the bank back under, or back within its capital ratio requirements. And then at some future date, it can be written back up, returned, once the bank is healthy enough to allow that.

And then the third kind is that there is what’s called a full write down, and that is when it’s just written to zero. No possible opportunity for gain, no convert into equity. And wouldn’t you know it, but Credit Suisse was one of the biggest issuers of full write down AT1s. So all of Credit Suisse’s AT1s were only full write down. They were not not contingent convertibles into equity.

There seems to be a uniqueness to the Swiss banking structure, although I haven’t actually found the regulations that require it. But the Credit Suisse was perhaps the largest issuer of these full write down AT1s. Does anybody want to guess who the second largest issuer is?

Dave: 18:40

UBS?

Brian: 18:41

UBS – Got it in one. The difference between euro preferreds is really in the contractual clauses. So AT1s typically have a much higher or much more defined contracts, right? At certain levels, they break, they trigger their clauses, whereas preferreds are at regulators discretion and the outcomes are less defined contractually.

Mike: 19:05

Now, is this also, some of the other regulators in the EU have come out and said our AT1s don’t quite work the same way as the Swiss do, because obviously, maybe there’s to be less appetite for offerings in this, now that we’ve actually seen a trigger event that writes down to zero? But is that some of the nuance we’re hearing about there on those, that sort of the UK sort of says, and I just very peripherally, so if you can maybe give some more details on that, it would be great.

Brian: 19:42

Yes. So that’s the full write down versus convertible sort of clause. The Swiss ones are only full write down. Most of the rest of Europe is convertible Coco into equity and they do not have a full write down clause.

Mike: 19:59

Right. So that’s that nuance. That’s the difference that some people were talking about. I’ve been hearing a few different things and I’m like, I don’t know, I’m going to talk to a guy on Friday. So yes.

Brian: 20:09

Yeah, that’s the big difference. Yeah, I mean, and it is, you know, on March 20th, which we’ll get to that pretty quick, right, but on March 20th, after the market learned technically on March 19th, that the market learned that the AT1 is being written to zero, that was a Sunday. But on the 20th, 1st trading day, basically the rest of Europe, the ECB, European Banking Authority, Bank of England, all came out and said, hey, no, wait, we’re not going to do this. This is a unique event.

It was very emphatic and very coordinated. I have some thoughts on that that maybe we’ll get to. But they were very clear. Now, contractually it can only be converted, right? There is not going to be a similar zeroing or unlikely, very unlikely to be a similar zeroing,
even if they run into trouble, right? It’ll just be a traditional convert to equity, most cases.

Mike: 21:12

So the Swiss, it’s always a zeroing…

Mike: 21:14

I believe. It’s been hard for me to officially confirm that, but every one that I’ve looked at, every prospectus has been a zero, full write down.

Mike: 21:24

Interesting, because you get a zero write down on these things. You get this 100 billion dollar backup from the Swiss government. It’s just an interesting…

Brian: 21:33

Yeah. So I’ll stop sharing this.

Dave: 21:40

Do you think that this just kills the market for this? I mean, the reason people have been buying these things, obviously, was that they were a higher yield vehicle from what they believed was a safe organization, right? So you think you’re getting a pretty good deal for the yield you’re getting. Obviously, in this case you weren’t. But do you think that this market just disappears? The AT1 market is down like 40% since this happened.

Brian: 22:00

Yeah, I don’t for two reasons. First, they are legally required to issue these securities in some combination. Now, there is what’s called a tier two, which sits between the tier one and the subordinated debt, or the senior unsecured, depending on the regulatory environment. But that market is much smaller than it used to be, and most of the issuance has gone into the AT1 market.

And so I don’t see it going away because they are required to issue this. Now, maybe their cost of capital goes up as a result of this, right, and they have to issue with higher coupons. We can look at the prices of some of these in a minute because you can see the effect of rates and stress on two different Credit Suisse’s AT1 coupons, at drastically different coupons, depending on the environment. I just think that continues to be a trend. What we’ve also seen is that previously, so these are all callable after five to ten years, and the banks were pretty religious about rolling them and calling them on their first call date.

A lot of that price move you’ve seen has just been the market, these things extending, and they’re not, no longer trading their call date, they’re trading somewhere beyond, as they extended. We might see more of that, right? The market might be less willing to price them to their calls, but that’s just the market figuring it out, right? Like eventually we’ll settle into some new normal. I dislike that term, but I think that’s what will happen right now.

Dave: 23:47

We know that we’re going to be facing a dearth of issuance anyway, because if you can avoid rolling, you’re not going to roll 5% up on what you were doing a couple of years ago, right? So if you’ve got it sitting out there, you’re going to let it sit at that lower rate.
It’s the same problem with mortgage refi.

Brian: 23:59

Well, the interesting thing, which I didn’t have that up there, but most of those, I think all of them are fixed to floating. So if they don’t call the call date right, so it still might produce. Yeah, but it’s still going to be a much more, I think, particular decision. So I think part of the price volatility I think, is warranted just from pricing past the call date, but not quite sure yet. I think the verdict is still out.

Adam: 24:32

Okay, so you still feel like this at one market is going to be useful for even Swiss banks to tap, given …

Mike: 24:41

Swiss bank? Is that even plural anymore?

Brian: 24:46

Well, so it’ll be interesting. No, the Swiss National Bank prior to this had been always been pretty clear. Like, we want two big Swiss banks. They liked having two. So I don’t know. We haven’t learned enough since this came out. It’s possible that they attempt to spin out the Credit Suisse’s Swiss Universal Bank operations into another bank. We haven’t learned enough about if that will happen or not. But it could. But no, I think to Adam, to your point, I think that’s where more of the damage is going to be, right? Because this UBS AT1s are the same as the Credit Suisse AT1s and the laws that the Swiss government passed to enable this, which we can get to, I can read them, affect UBS or could affect UBS as well if they were to run into a similar problem. So far, that hasn’t happened yet outside of the pricing of the AT1s, but it applies, so we’ll see.

Mike: 25:54

All right, keep going. I’m on the edge of my seat, bro.

Dave: 25:51

No, I want to get into the shenanigans part of this, because that’s part of what I wanted to really come talk about, because I had not paid much attention to this. But this did not go down in the normal way. This was not a normal course of business. This got laws passed right, ahead of time.

Brian: 26:13

Yes. So, yeah, we’ll skip to the write down or the week of March 13th. So I’ll go day by day, and then I’ll read out the laws that were passed out.

So March 13. It was a Monday. That’s when the sell off in credits, seems to have really kicked into gear, and we can look at some prices in a minute. Actually, I’ll do that now. I’ll put the prices up now so you can marvel at them while I talk.

Mike: 26:58

So while we’re on the break there, I think, Brian, your mic is picking up a little bit of rattling, almost like there’s a loose screw in it or something. No big deal. But if it happens again, I’ll let you know, and maybe just give it a jiggle, because I think you hit your desk a couple of times and actually stopped doing it. That’s kind of how I think I. Figured out it was you.

Brian: 27:15

Yeah, my mic is right here. Like it’s the same. Let me know. Okay. So March 13th is when the sell off in the Credit Suisse bonds really picked up. March 14th, they finally released their annual report. It had been delayed by a week, because US regulators had some comments on it. And when they finally released it on March 14th, they admitted to a material weakness in their financial controls. They also stopped paying bonuses to the board because of that.

March 15th is when the Saudi National Bank says, absolutely not, if they are going to inject more capital, which triggers the big panic. The equity sells off, I think, 20 or 24% that day. But at the same time, same day, March 15th,  FINMA, the Swiss financial regulator, confirms that Credit Suisse is solvent. They sort of say, hey, no, this is okay. Of course they’re going to say that. But they said it publicly, which is important for what’s about to happen.

March 16th the Swiss government issues a statement of support for Credit Suisse and then approves a new liquidity line for them to draw on. And then after, that same day, but after they approve the liquidity line, they pass a new law, which I will read out. So, FINMA confirms the creditworthiness of the borrower or confirms the existence of a restructuring plan. Now, they did that. They confirmed the credit worthiness of the borrower the day before, on March 15th, when they said it was solvent, and Credit Suisse had been trying to execute a very robust restructuring plan, which is part of why it was showing up as a big trade, a big overweight in a lot of fixed income funds. But, goes on, if the borrower is part of a financial group, this is related to the hold code, confirms for the entire group. But this is saying they confirmed it. This happened, it was credit worthy, and it had a restructuring plan. So that was the law that was passed on March 16th.

On March 17th, the Wall Street Journal reports that Credit Suisse saw deposit outflows of $10 billion in the last week. Huge outflows from the deposit base. They had already been under outflow pressure on their deposits in 2022, especially the fourth quarter, like, way before the SVB stuff happened. And banks were like, oh, should we raise our deposit rates to keep people from freaking out, or whatever? All the other stuff that happened during and after SVB, Credit Suisse had already been seeing deposit outflows, and that accelerated this week.

And then March 19th, which is a Sunday, another law was passed. They announced that UBS was taking over. Another law was passed, and the AT1s were zeroed. The other law that was passed, the literal law is, at the time the loan is approved, this is referring to the liquidity lifeline that the government, through Credit Suisse on the 16th, at the time the loan is approved, in accordance with Article Five, that was the first law I read, FINMA can order the borrower to write off additional tier one capital, and that’s why they were zeroed.

Dave: 30:40

So they literally just made up a capability that did not exist and then basically said, now go do that thing.

Brian: 30:52

Yes. So here there’s additional commentary. This is from the same law, but additional commentary, in this context, …, as soon as the commitment credit is approved, that’s the lifeline, the amortization of additional tier one capital, the order in question can be addressed to the borrower and to the group, that’s opco versus holdco. Um, now, this is important as well. The amortization of additional tier one capital may also be ordered with a view to a takeover or repurchase scenario, without which the borrower would have immediately been found insolvent. So that is where the zero came from.

Mike: 31:36

That’s wild. I got to hand it to that coordinated effort to make all of this stuff happen.

Dave: 31:43

… of a government that can act that quickly to pass actual law. It’s one thing if a regulator comes in and just puts a stamp on something, but this is a whole different thing.

Mike: 31:56

Oh, I know. Well, when your whole economy is, hey, we’re the bank that banks, we’re the country that banks the world. Right. Yeah. You got a credibility issue. You’re going to have to get on it now.

Dave: 32:10

Is there any implication for the other Swiss bank/banks? Are there more than one? I mean, yes, there are, but still…

Brian: 32:18

The laws that were passed can be used on any Swiss bank, right? So those are now laws. Unless they, I don’t know, once this is complete and approved right, because the merger actually hasn’t happened yet, or been approved or confirmed. Maybe they go and they strike them out after it’s done right, and just go back to the way things were. I don’t know. But at the moment, yeah, they apply to the whole Swiss banking market.

Adam: 33:02

It sounds like there was at least some reasonable and ambiguity about where AT1s stood in the capital waterfall prior to the Swiss government and the Swiss regulators changing the laws. Why do you think they changed the laws in this direction to zero out the AT1s rather than allowing equity to be wiped out first? And it just seems to me to make it a lot harder to issue that kind of capital going forward for UBS with this new perception of the capital waterfall. Any intuitions on that?

Brian: 33:50

Yeah. So there’s a firm answer to part of that, and a speculative answer the other part. So on the more concrete side…

Mike: 33:57

We got that peanut running around in your microphone.

Brian: 34:01

How about now?

Mike: 34:04

Can you try and tighten your microphone? It might be, like, the vibrations or is there a screw on it or something?

Brian: 34:12

How about now?

Adam: 34:15

Yes, that’s better.

Brian: 34:18

Okay. It’s just a clip. I don’t know. Sorry about that. So, on whether this, there was some ambiguity, that was my initial reaction was first, like, oh my gosh, I can’t believe they did this. Then I swung the way opposite side and said, oh, well, of course it was in the prospectus. Where it shows up in the prospectus is not in one of the contractual clauses, but in the sort of list of risk factors that comes at the end of any prospectus. And it was thrown in as an example of what might happen.

But right before that, in like, two lines above it, it said, oh, well, we’re going to respect, like, this will happen in order of what, the normal waterfall. So it was very ambiguous, and I think it was ambiguous enough that there is a legitimate sort of legal effort underway now to sue. So even though the AT1s technically have been zeroed, I’ve been able to find some prices on them in the low single dollar range since then, and some hedge funds have been buying them up over the counter as a form of litigation finance,

I think, so, we’ll see. But the story might not be over yet. But to the point where people think that they have a legitimate legal claim here, I think the fact that they had, that the Swiss felt like they needed to pass a law to make this happen, I think that answers the question of would this have held up in court without that, right? Now, maybe they’re just being, covering all their bases, but I think that’s sort of the key fact. The law is really the giveaway that they …

Adam: 36:03

… that there was ambiguity before, right?

Brian: 36:05

Yeah, exactly.

Adam: 36:08

And what was the value of the AT1s of Credit Suisse’s? Like, how much are we talking about that they zeroed out?

Brian: 36:18

$16 or $17 billion US.

Adam: 36:21

Okay. Yeah. So not peanuts, right? So is it reasonable then, to say that, well, actually, let me start with what would happen, do you think, to UBS, to the merger, to the Swiss banking system, if that zeroing out of AT1s is overturned and instead they adhere to the traditional waterfall? What would be the implications to the banking system, do you think?

Brian: 37:00

I think I’m going to sort of invert that and try to answer it a different way. So I think the way that they did this seems to indicate to me and this is where we enter the speculative part of the conversation that they were, I think, pretty clearly not operating from a purely pure market perspective. There was politics and emotions involved in this decision, but, now, obviously, they wanted to protect the equity holders of Credit Suisse. From what we can tell, it’s pretty clear that Credit Suisse equity was widely held within Switzerland.
So they’re protecting their demographic, their base, you could say. Oh, well, what about the Saudis or other owners? Personally, I think that that was less of a concern than the home-ownership, the homebase, the constituents. At the same time, they apparently did not at all entertain the bid from BlackRock, the potential bid from BlackRock, which tells me, again, they wanted to handle this internally. I think maybe the insularness of the Swiss banking industry, what made it so attractive historically, also made them really reluctant to violate, sort of their neutrality, if you will, right? I think that played a big role into that. And maybe the concern was, if they want to solve it internally, this is a Swiss problem. It requires a Swiss solution.

UBS, UBS clearly didn’t want to do this, right? Their first offer was low ball. So how do you strong arm UBS into doing this? Well, what are UBS’s requirements? Well, they don’t want to swallow another $17 billion of debt, and maybe UBS held a lot of Credit Suisse equity. So here’s the outcome. I don’t know how they’re going to perceive or, you know, react to the outside market’s reaction to this decision, meaning the pricing of Swiss AT1s, maybe outflows from the Swiss banking market. Because now, look at what you’ve done, and this is the Swiss we’re talking about. This isn’t Italy or Spain. So I don’t know. Frankly, I think that’s a very unanswered question that’s going to take years to answer.

Dave: 39:31

It seems to me like there has to be a black eye on the Swiss banking sector as an entity, because not only with this, we’ve also got sort of numerous sort of accusations of things that the Swiss have been doing to help US customers in ways they shouldn’t have been doing. So, all of the sort of Swiss privacy stuff seems to have had a lot of chinks in that armor over the last decade, frankly, but certainly more now. And now we’ve got the sort of independence of the Swiss banking system sort of in question, because it’s sort of now just governmental fiat. Who wins and who loses, seems to me it’s a pretty strong signal that you’re not going to see billionaires parking quite so much wealth over there.

Brian: 40:10

Yeah, I think that has to be an outcome to this.

Adam: 40:16

To the extent, is this a systemic risk, if it turns out that there’s a valid legal case against the Swiss regulator, against the Swiss National Bank, I mean, that’s clearly why investors are buying these AT1s at prices above zero. They’re speculating that there may be a legal case. I guess what I’m wondering is, is the price of Credit Suisse AT1s now an interesting potential indicator of escalation of systemic risk?

The context there would be if you’re going to force the Swiss National Bank or the Swiss regulators to flip flop on their decision to wipe out AT1s and instead adhere to the typical capital waterfall and wipe out shareholders, would that represent a reinterpretation of the systemic risk of the Swiss banking system? Would UBS have the option to reneg on that deal? I’m just, this seems to me to be, this uncertainty and ambiguity seems to be both maybe an underpriced systemic risk and AT1 bond prices may be underappreciated as a potential canary in the coal mine?

Brian: 41:44

I think obviously there’s huge ramifications to that. The ripples, we don’t see that. We don’t know them all yet. When it comes to the AT1 market broadly, yeah, it’s traded down huge. I don’t know if Dave, do you still have that picture of the index? We can throw that up.

At the same time, asset managers that run corporate or financials heavy strategies, or have expertise in this market, they’ve just been gobbling these things up. Not, outside of the Swiss market, right. But English bank AT1s, continental Europe, the ones that don’t have this full write down feature, it’s presented a pretty big buying opportunity to them. Now, whether they rebound, right, and the market gets over what’s going on, I’m going to assume that they will price somewhere between where they’re at now or have been, versus historical rate. Because like I said before, they’re not all trading the call now. I think that’s the most likely outcome. But yes, I think there is, if people, obviously banking is a trust system, not just financial system. And if banks can’t trust their regulators, investors can’t trust their regulators, I think that’s a huge.

Mike: 43:13

Which investors can trust their regulators to do what for whom?

Brian: 43:22

I don’t think really, when has a regulator acted against the capital markets so directly?
Obviously, that’s a big question.

Adam: 43:31

Where are UBS AT1s trading. Are they trading substantially lower now that they’ve, that the Swiss government has made explicit how they’re going to treat them?

Brian: 43:40

Yeah, I don’t know the price right now, but yes, I think they’re down at least at least 30 points.

Mike: 43:50

Do you have that chart, Dave?

Dave: 43:53

I have the index for all the euro denominated, which you could throw that up. You’ll see that’s down 25%.

Adam: 43:56

Are they, or are they euro denominated?

Dave: 44:01

This is the broad big index.

Dave: 44:05

So this is hitting the entire AT1 market in Europe. So it’s not specifically, but you can see it’s just obviously crushed this, as part of the capital structure for everybody. Right. Everybody suffers when something like this happens. It doesn’t seem much way around it, but I mean, again, you have to ask them, does that create an opportunity for buyers, right? Because do you really believe that UBS is the next one that’s going to go under and they’re going to wipe out the AT1s there too? That seems like you got to be pretty catastrophizing to get there.

Adam: 44:38

It is interesting, though, that the Swiss banking regulator flip flopped on banking rules in the span of a weekend. The Swiss, and yet investors are now believing that the other European regulators are not going to flip flop when the chips are down.

Brian: 45:03

Yeah, that’s where my logic has sort of taken me is, everybody came out, ECB, Bank of England, all came out like, hey, we’re not going to do this, you’re not going to see this repeated. But at the same time, a new precedent has been set. If their backs are up against the wall, if there is some sort of political decision, right? This was a political and emotional decision from the Swiss regulators. If a similar central bank is in the same situation, it’s no longer zero,  right, the risk of this.

Dave: 45:40

It’s almost like the opposite of the Fed put. It’s like a Fed call. They just get to come in and smack somebody because they…

Mike: 45:46

It’s the covered call, really. It’s short call, shorter call.

Adam: 45:51

Yeah. So what other banks in Europe? I mean, I know Credit Suisse was a bit of a special case, the way that Silicon Valley Bank was a bit of a special case, for completely different reasons, but I know that they were a special case. What are some other potential nexuses of risk in the European banking system, for those who want to pay attention? And I don’t want Associate Director of Fixed Income Research at Morningstar to trigger a bank run here, but I’m just curious, generally, what kind of bond indices would be most likely to flash to provide warning signs first?

Mike: 46:44

What Adam is trying to ask is, now that the tide is rolling out, can you point us to the naked swimmers?

Brian: 46:55

I haven’t taken a closer look. This I mean, I think the gut reaction is Deutsche Bank, but that isn’t like, Deutsche is nowhere near  as widely held, at least from what I can tell, and I haven’t taken a super close look at this yet, but it’s not as widely held as Credit Suisse was in public fixed income funds. And it is still healthier than Credit Suisse was, which is funny to, obviously Deutsche has had its own long history of problems, but it had recently sort of been honestly turned around, but it had been in better shape.

Now, they don’t follow the same Swiss banking rules. Their AT1s have a different structure, they have a different cap stack, so they have not been under the same deposit outflow pressure that Credit Suisse was. So, I think the market that was like, the market basically went SVB. Who’s the next weakest link? Credit Suisse. And then the market, where is the market going to push around? Who’s the market going to push around next? And after Credit Suisse was Deutsche. And then, frankly, from our perspective, that chatter has already sort of dissipated in the last couple of days. Who knows, right? And I think sans deposit outflows, that’s the killer. Deposit outflows and then counterparties. And as long as neither of those two things happen to a large degree, I don’t think we see contagion. I think those are the two sort of determinant factors.

Adam: 48:38

There were two holes in the dyke. We got two thumbs and we put them into holes and now we’re in good shape.

Mike: 48:46

We’re on metaphor fire. Metaphorically, we’re on fire.

Dave: 48:48

I mean, it’s still worth pointing out that we do have plenty of banks that have large held to maturity positions that probably should be marked to market. I don’t think all the dust is over. But it does seem like most of the rest of it is fairly predictable. I mean, you can go pull up how upside down people are in their bond portfolios for every major bank now, and we all know how to look at that. So, it doesn’t feel to me like there’s a giant unknown/unknown that feels scary. Right?

Brian: 49:06

Yeah, that’s a really good point because I think that one of the knock-on effects, at least as it most relates to my work, is that overweight to the financials that’s been there for years, does that change right? Is the market, and what does that do if the trillion dollar plus asset management industry is no longer overweight financials, what does that do to their cost of capital? What is the knock-on effects of that? Because if they are forced to raise deposit rates, which you would think they would be, but obviously I think that hasn’t necessarily happened yet, at least for somebody like JPMorgan, does the thesis for owning them, the stated thesis that net interest margins are going to expand, that goes away. That’s TBD. If it does go away – we haven’t actually seen that yet, but I think that’s the risk. And then you get into what happens when all of that money is no longer persistently over-buying part of the market. I do want to put up…

Mike: 50:23

Can we come back? I just want to make sure you cover one thing because we wanted to talk about, AT1s got written down to zero, but that had a follow on effects to the rest of the capital stack and they were a little bit counterintuitive. So I don’t know if that’s where you’re going now next, if you are awesome or if you have plans to talk about it. And then I’m wondering as sort of addendum to that sort of question or feature if we think about, so there was 16 billion of approximately AT1s that went to zero. And then what was the appreciation of the other bonds? There’s a spoiler alert. Was it offsetting? And then who owned what? So was it a calculation across the board of, okay, well, we’ve got institutional investors that own this, and they also tend to own this other thing.

Brian: 51:17

Yes, I put in a new spreadsheet to share with some of that. So let me make this a little bit bigger so we can, I don’t know how hard this is to read, sorry, but this is a couple of different funds that I picked out. One to get a decently broad spectrum, but also that sort of rose to the top. So the material columns are here. This one … that’s his total Credit Suisse exposure. And then this is their AT1 exposure.

Now, a quick caveat. This is not necessarily up to date. So the portfolio day here is the column that this data is based off of. And they don’t have to submit, they’re not ETFs. Sorry, Dave. They don’t have to submit their portfolios daily. And so we won’t always know, obviously, day by day what’s happening in the portfolios. But this is sort of a great example of the Credit Suisse trade that they were very overweight. A number of managers were very overweight this name, but they were playing it differently, depending on their assessment, their risk appetite and so on.

And so just as an example, I’ll look at Investco Core Plus. They had a pretty big Credit Suisse bet, about a third of which was in AT1 exposure, and they ended up doing very badly on March 20th and then for that sort of full week, compared to a lot of peers and what happened, what Mike you’re getting at, is that on March 20th, which was the day
that they were marked to zero in these portfolios, right, It happened on the 19th. But the first day that Navis struck as the 20th, the AT1s went to zero. But the senior bonds, which I had up in that other chart, they all spiked.

They had been trading down in the $70, $60 to $70 range, they all spiked back up to over 90, close to 100 just in that day. So if you’ve been buying them in the last week, the prior week at in the $70, $65, $80 range, you in one day picked up a pretty nice return.
And since then, they’ve traded even higher. I looked at one this morning, it was at 102. Because what’s happening is that the Credit Suisse Senior Unsecured bonds, which is where a lot of this exposure is, right? If it’s not AT1 in this chart, if it’s not AT1, it’s Senior Unsecured. What happened is that they traditionally traded at much wider spreads than UBS Senior Unsecured, given the relative health and strength of the banks.

And what’s happening now is that the market expects those two spreads to converge in some fashion to some degree. And so as a result, the people who own Senior Unsecureds, not all of them from what we can tell, sold them right away. A lot of them are holding onto it because they expect prices to grind even higher as the spreads converge, which seems to have started to happen already.

Dave: 54:25

Can I ask you a question, Brian? Because you talk to these folks, this is your job. You’re one of those folks that actually talks to PM’s and tries to understand the way different individual PM’s trade and how they think about credit. So I look at the Western Asset blocks here, who are both obviously, both these funds are big owners. But also kind of miraculously, they go from having a really terrible day, to having their book flat at the end of this period, which I think most people would consider that a pretty winning trade if you were a major holder of anything with Credit Suisse in the title and you managed to ride through this flat, I think we’d all take that as a win. Do you think that that’s a result of a lot of active trading on their part, or do you think that they simply got the positioning right and that their buy-ins on the more senior debt, which had that spike, really just offset the losses in the At1s?

Brian: 55:12

Yeah. So this is my current project that I’m working on, and I think what I always tell the analysts that report to me and then I help teach, this stuff is a mosaic, especially in fixed income portfolio construction. There are a lot of variability. There’s a lot of variability to this and to the outcomes. So, for example, I’ll use a real clean one. It’s the one I currently have the most information on, and that’s the Met West Fund, which only owned the seniors, didn’t own any of the AT1s, and did well.

And they still lost 31 bips on the 20th, but did well. Better than peers, better than anybody else on this list. And then its return for that whole period, the week is among the best in the category, best on the page here. And that was because they only owned the seniors, and then they were overweight the two year, which, if you recall, we haven’t gotten to this yet, but obviously that caused a big ruckus in a lot of markets. The collapse in the two year yield on March 20th, if you were overweight the two year key rate, that had a huge, maybe even a bigger impact on performance during this period, than just your Credit Suisse exposure.

Now, some of these managers, this is where it gets into trying to draw very fine distinctions. But some of these managers we’ve talked to more recently, and some of them were buying the Senior Unsecureds during this period when they were selling off. Other asset managers on this list were trying to sell everything. And what happened was that AT1 liquidity, normally a fairly liquid market, $270,000,000,000 that week, the week of March 13th, every day liquidity in that AT1 market, and Credit Suisse AT1s just got worse and worse.

And so by Wednesday, Thursday, if you hadn’t sold by then, you were kind of stuck with it. And so we get all of these different outcomes, which it’s hard to parse this on the page, but sometimes you can see pretty clear performance differentials based on some of these factors. And it’s our job, my job and my team’s job, to understand the decision making that went into one, building the position in the first place, and why you chose what part of the cap structure you did, and then your decision making during this period.
Were you buying? Were you selling? Were you selling because you weren’t confident in your thesis and you freaked out? Or are you selling because your enterprise risk manager said, hey, margin called it, sell it off today.

This is stuff we’re still trying to figure out. On the duration, were you overweight duration? Well, if you were overweight the 20 year, the 30 year, and underweight the two year, that didn’t help at all, versus where the key rate exposure was.

So this is where we spend the bulk of our time. And it’s hard to parse, like I said, just looking at this, but you can see some pretty clear sort of examples or distinctions between some of these. Yeah.

Dave: 58:19

And worth pointing out, these are like half percent moves in bond portfolios in a handful of days, which these look like very small numbers. God bless diversification. But these are big moves in bond portfolios.

Adam: 58:32

Yes, good point. Do you think some of these guys had these riskier AT1 positions on and were also long the two year as a hedge? They’re like, yeah, okay, these are risky, but I’ve got a lot of pickup from owning them. And in the event that there’s a bank run on these, then the two year is going to crash higher, and that’s going to act as a really nice hedge.

Brian: 59:03

I don’t think it was as explicit as that, but yes, right. Some of these on this list, we know for sure, owned the At1s and were also overweight the two year. I haven’t finished talking to all of these managers, which is why that column is pretty empty at this point, but I do know that to be the case for some of these. But it was not as explicit as a hedge against this trade. It was, all right, we like Credit Suisse. Some of these pay a really high coupon, and also the curve is massively inverted, and if we expect any sort of recession or Fed pivot or whatever, it’s going to be most pronounced in the two year. So that’s where we’re going to lay most of our bet, most of our duration overweight on the two year part.

Adam: 59:42

So they were betting on an economic pivot anyway. They weren’t buying as a specific hedge against some of their…

Mike: 59:57

I was going to say, Adam, you were getting into the really long mustache guy in the
corner who thought of that. Was getting along. I got to meet him. What’s the size of the market, of the capital structure that did so well? What’s the overall size of that market? So 16 bill went to $0. What was the appreciation, the 30% appreciation of the other stuff? Was that half the amount?

Brian: 00:36

No, it’s more than more, I think so. I don’t have the number in front of me, but I’m fairly certain it’s more. Those bonds tend to be bigger.

Miker: 00:40

Yeah. So that would go in as a Swiss person sitting around that table twisting my long mustache over those days when things were happening. That would be something that you would probably, we’d all be considering, too. Okay, so we have these bondholders, and they’re largely the same people. If we wipe out the AT1s, they’re full and we don’t have to, and we get our votes with our capital structure, too, with our common equity dollars.

Adam: 01:01:17

Yeah. Well, first of all, did we kind of cover the bulk of the technical details and the drama around the…

Brian: 01:01:30

Yes.

Adam: 01:01:32

Okay, so where are the opportunities? Are there any opportunities left here? Or has the AT1 market corrected back to where we’re probably near an equilibrium, or are there still dislocations out there that some bond funds have taken advantage of, are taking advantage of, and may represent tactical opportunities in the fixed income space?

Brian: 01:01:55

Yeah, I don’t think that the AT1 market has fully corrected itself yet, right? It hasn’t come back anywhere near where it was. That being said, I think like we said before, the risk is no longer zero that events like this happen, but it’s still pretty low. And I do think that market, just based on what we’re hearing from asset managers who invest heavily in this market, the consensus, for better or worse, is that, yeah, this is going to come back, no problem. This is market panic, market dislocation, not reflected in fundamentals, et cetera. That’s the consistent refrain we’ve heard from everybody over the last two weeks.

Adam: 01:02:41

This is a bit nuanced because I’m curious whether the market has priced any particular jurisdiction with a higher probability that that jurisdiction will buckle the same way the Swiss buckled. For example, has the market repriced Euro jurisdictional bonds differently than pound, UK jurisdictional bonds? Is there any arbitrage going on there?

Brian: 01:03:18

I don’t have the region by region or country by country breakdown to look at right now. I do know that, for example, US preferreds traded down sort of in sympathy, despite yes, they fill the same role in the cap structure, but they are not necessarily equivalent in terms of their prospectuses and their contracts. They traded down maybe close to 40 or 50 points in sympathy with the AT1 market, which I think that’s probably a reasonable arbitrage opportunity. Right. I mean, full disclosure, I’m not a credit or an equity analyst, but I think there is clearly this is a baby with the bathwater moment again. This is what we’ve been hearing from everybody and I think eventually there will be some sort of tiering among these, right?

Brian: 01:04:09

As everybody reads through their docs a bit closer, parses the language of the various regulators and central banks, like that’s happening right now. I just don’t think it’s, the outcome of that is to be determined and I think this is where right, if there is an arbitrage opportunity, it’s happening right now. We just haven’t seen the outcome that yet.

Adam: 01:04:31

Yeah, we’ll see the results of that in hedge fund and in active bond funds over the next three to six months. Right?

Brian: 01:04:38

Exactly. Yeah. It’ll be really interesting to look at March portfolios, which we’lll start to get in April and May, but that’s when we’ll be able to go back and take a closer look and see just how much things changed.

Dave: 01:04:46

But it doesn’t look like we have an example of somebody who’s making a career off of having called this perfectly, right? I mean, none of the funds, they had 2% spikes on the day, right? So it doesn’t strike me that this is sort of one of those seminal events where you say, oh, well, I guess we have to listen to this guy for the next ten years because he built his performance on this three day window, which happens, I mean, it happens in almost every market. That doesn’t seem like anybody called this necessarily.

Adam: 01:05:20

I’m wondering if the opposite might be true, right? A hedge fund’s out there earning carry through capital structure arbitrage, long, the AT1s, short the senior sub debt and got massively upside down on that arb trade.

Dave: 01:05:37

That seems more likely.

Adam: 01:05:40

And got carried out.

Brian: 01:05:42

Yeah. And I think I’ll put this to you, all right? So from our perspective, what we’re thinking about or looking at is where you placed your trade on Credit Suisse, why you did it? But I think from your perspective, the AT1 market as a whole, which that chart Dave, that had up earlier, showed AT1 market as a whole, until the end of last month, had massively outperformed pretty much almost every other fixed income index over the last ten years, right? And so, from how do you decide about building a portfolio where okay, the upside is a nine and a half percent coupon, you’re outperforming everything, even US. high yield, with the same volatility, or not much greater. But the downside tail risk is you get zeroed, depending if you’ve read your docs enough, versus earning a bit less on the senior unsecured, or building the portfolio between those, like making that decision and where to place your bets, that’s something that this is ultimately what the outcome of all of this will be for us.

But I want to turn around and ask you all if you were to place one of those bets, or how you think about putting capital at risk versus the tail risk of a position like that.

Adam: 01:07:02

Well, I think actually from the position of a manager ,is a question that managers kind of face every day, right? There’s all kinds of potential carry trades out there that you can put on to earn extra yield, while the market is behaving normally, right? You know, in the back of your mind, if you’ve got any sense about you at all, that you are short a disaster option to earn that extra premium, right? But, was it Chuck Prince who said, while the music is playing, you got to dance, right? So you’ve got all these active bond managers who, the more prudent ones or the most prudent ones, let’s say, may have avoided that space altogether because they weren’t comfortable with the negative optionality on this kind of situation for ten years, and underperformed, right? And therefore probably endured some kind of asset bleed at the margin because they weren’t participating. They weren’t dancing while the music was playing. And to Mike’s point earlier, right, you only see who’s been swimming naked when the tide goes out.

So, how does an investor look through a portfolio and decide whether they want to take these kinds of asymmetric risks in order to earn a potential, whatever it is, half point, 1 point extra yield on the risk that you give it all back in a few weeks, when and if this particular catastrophe materializes.

Mike: 01:08:58

Just, I want to add to that too, that the manager themselves is bound by whatever restrictions are in their portfolio. So we come back to that mandate flexibility and portfolio agility. Did the marketplace dictate to them what they were going to do anyway, given whatever structure they were in, their ability to even have or not have a hedge, and so putting a lot of guardrails around any of the decisions that they would have made. Are they someone who will encounter some tracking error to some sort of benchmark? Are they able to be more active in their trading? Again, coming back to that portfolio agility and mandate flexibility, and like you say, Adam, it’s probably those who had the ability to shoot themselves in the face that shot themselves in the face, that were carried out, as we say.

But there’s a whole bunch of structural issues there too that fall into it, as to, I mean, a bias in the market. I could hedge a position in some way, shape or form, but I can’t speculate on the other side. So I’m constructing this short disaster bond that I want to get a yield on, and is there another place where I could structure a trade that was a tail trade that paid off and the cost of that insurance was less than the cost, or the potential benefit of that insurance in a doomsday. So I’m getting like a free carry. But then you’d have to have a fund structured to do said thing. That’s complicated.

Adam: 01:10:25

Yeah, I mean, you could have bought far out of the money. You could have rolled far out of the money Eurobor options, and rolled those for ten years and ate a very small portion of capital for ten years against your excess yield on AT1s. And the gamma on that would have been so unbelievably explosive over those past, over those two weeks that you would have been more than made whole.

Mike: 01:11:02

You’d have a windfall.

Dave: 01:11:05

Yeah. That’s a long trade, though. They get …

Adam: 01:11:09

Totally long trade. And who’s got the discipline to maintain that name?

Mike: 01:11:15

No, that dude got fired in year two. Oh, yeah. There was a dude doing that. I ran into him. He was driving an Uber, getting a ride at the airport.

Adam: 01:11:27

But this is the perverse incentives that we face in the asset management industry, right? Like, you get paid for ten years for picking up nickels in front of a steamroller. You gather more assets, you earn a lot more fees on those assets. You look like a hero because you’re taking more risk, but the risk is hidden. If you’re a less scrupulous fund manager, or to Mike’s point, you’ve got a mandate to take that kind of risk, but the investors don’t know, really the details of that risk that they’re taking in order to earn that premium.

Mike: 01:12:03

Did they kind of ever really even? Brian’s stating, you got to dig into your AT1 and read it now?

Brian: 01:12:16

Yeah. One of the interesting things for us, like peeling back this event is going to take a lot of our time. We don’t do this for every trade, obviously. That’d be too much work, right? But we use it as a look through or a case study into decision making. And there’s so many layers to this. To go back to example, for a fund, let’s say a fund had exposure in the seniors and the AT1s. Then their Enterprise Committee said, no, you got to sell it all now.

Now, maybe they were only able to sell part of it. Maybe they sold the seniors and half of the AT1s, or whatever the makeup is. But my first reaction might be, okay, well, if you had this strongly held thesis, why were you so quick to sell it? And they say, okay, it was the Enterprise Manager. Okay, well, I get that. Then it might be second or third order. Okay, well, even though it was a complete reversal of their thesis, maybe they were able to sell enough that they still managed to lose less than if they had held it and stayed with their thesis, right? Like, how do we unpack that? It’s just a huge question for us.

Adam: 01:13:23

And there’s a lot of luck and policy in there, right? Like, who do you need to ask in order to take these kind of steps? What’s the authority of the manager versus the Risk Committee?

Dave: 01:13:41

Well, how good your trading desk is, too, right? Because these aren’t exchange markets, right? So if you’re sitting on a couple of hundred million dollars of AT1 debt, you don’t know the right guy to call on a Tuesday, you’re not getting the trade.

Adam: 01:14:01

Yeah, absolutely. Well, that’s why the job is difficult and not everyone can do it. And hey, you like these kind of puzzles, right? So you’re rubbing your hands together, waiting to get your fingers dirty here.

Brian: 01:14:15

Yeah. This is the stuff where I think it’s a wonderful window into asset manager decision making. You have a normal conversation with them, there’s not much to talk about. You learn some stuff, you become friendly with them. But this is the kind of event where you can actually understand or unpack all the layers we just talked about. Their business or enterprise risk, like, how they interact with them. Were their traders able to do something and another team’s traders weren’t? Like all that stuff. It suddenly crystallizes, or at least becomes clearer in moments like this. And so for people like me and my team, this is where we…

Dave: 01:14:53

You get a quarter for the stuff to write about.

Brian: 01:15:00

Yes. At least.

Adam: 01:15:03

Well, we’d be remiss if in your capacity as Associate Director of Fixed Income at Morningstar Research, we didn’t ask you about your price target for Dogecoin before we left?

Brian: 01:15:20

I don’t think I would even know how to well, I can Google it.

Dave: 01:15:25

I go zero. Zero is always a good price target.

Mike: 01:15:31

That’ll be controversial.

Dave: 01:15:35

All about engagement, right?

Mike: 01:15:38

In case anyone was uncertain, that was parody. Oh, man. I just want to be clear. Yeah. What a great discussion. And I think we should remind everybody, no individual opinions on any of the securities mentioned here. We don’t trade or hold any of these types of things. So just putting that out there, the compliance ending.

All right, any final thoughts? I feel like we’re wrapping up.

Brian: 01:16:04

Yeah. We got through everything I think we wanted to get through. I wanted I mean, this was I appreciate you having me. This is great. Fascinating.

Adam: 01:16:24

This is super insightful. Yeah. Really interesting. I loved it. Yeah. So, Brian, thank you so much. Dave, we didn’t get into your role as financial futurist. Next time.

Brian: 01:16:34

Letting me take. I feel like I chewed up most of the oxygen.

Mike: 01:16:41

No, I know. That’s the gut that you’re kind of supposed to in this case. You’re a Mick here. I’m playing bass. We got Adam on drums.

Dave: 01:17:54

I’m a groupie.

Mike: 01:18:00

Yeah. Putting you at lead guitarist, but okay.

Adam: 01:18:05

I thought I was Keith Richards, but you’re going to make give Dave that. He does have the guitar.

Adam 01:17:05

Anyway, before we waste too much more time, thank you to everyone who tuned in. Thank you, Brian. Thank you, Dave. And thanks to everyone else who asked questions and commented, and we hope to see you back here next week.

Speaker 1 01:17:17

Yeah, propagate this message too, because this is not widely known out there information, so Like and Share as you will. Well, thanks for having us and thanks, Brian. Thanks, guys.

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*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.