CoCos market set to change permanently after Credit Suisse crisis

The collapse of Silicon Valley Bank (SVB) and the subsequent Credit Suisse crisis have caused the selling panic seen in the equity markets over the last week, but its impact on others such as structured bonds could be greater and even permanent.

MAPFRE Inversión's chief economist, Alberto Matellán, explains that the market for AT1, or contingent convertible capital instruments, (CoCos, as they are known in the trade), as well as other structured fixed income financial instruments, "is very dispersed and highly variable".

CoCos are a hybrid issue with debt and equity characteristics, as they pay interest to the investor and feature loss-absorbing capacity. Despite being highly technical instruments, they have made headlines lately: Credit Suisse's CoCos are to be valued at zero, as stated by UBS in the acquisition agreement. This valuation would represent a write-off of $17 billion (15.76 billion euros) for the bond holders, while shareholders would retain some value.

"Each instrument is very different from the others. You have to read the fine print and that’s what causes some instruments to react differently to others," he said.
In addition, Daniel Sancho, head of investments at MAPFRE Inversión, reminds us that at times like this, it’s always possible to find opportunities, given the increase in AT1 spreads due to the higher perceived risk over recent days.

No contagion

The problems at SVB and Credit Suisse over the last week or so have given investors pause to consider possible contagion across the financial system, something that Matellán rules out for the moment, explaining that when this phenomenon does occur, confidence falls both in banks with problems and those without and that liquidity is withdrawn from both equally.

"There are specific issues in certain institutions. It’s normal that some of them are facing problems when rates rise or the economy slows down, but contagion is another thing entirely and it’s not something we’re seeing right now," he added.

MAPFRE Inversión's chief economist insists that these are one-off problems that have occurred in some banks, adding that many of them across the board now have much more solid capital structures in place.

"Over the last 10 or 15 years, the management of banks has improved and so have the regulatory requirements. They are now better capitalized than before. The question is whether they are sufficiently capitalized to absorb those losses," he stressed.

The role of central banks

As far as central banks are concerned, the important thing is to avoid sending a panic message to the market: they must ensure liquidity and underpin investors’ confidence in the system. Matellán believes that it’s possible to combine fighting inflation and providing liquidity to institutions, as long as it’s considered a short-term measure.

"Central banks have two mandates: to control inflation and to maintain financial stability. In the short term, both can be managed, but it’s not as clear cut as that in the long run. To maintain financial stability, you have to provide liquidity in order to avoid contagion, and as long as that is temporary and limited in terms of time, it’s not a problem," he explains.