The collapse of Silicon Valley Bank (SVB) and the subsequent Credit Suisse crisis may have caused panic selling in equity markets over the last couple of weeks, but the impact on structured bonds could be greater and even permanent, says MAPFRE Inversión chief economist Alberto Matellán.
The warning centres on the the market for AT1, or contingent convertible capital instruments, (CoCos), as well as other structured fixed income financial instruments. Matellán describes the market as "very dispersed and highly variable".
CoCos are a hybrid issue with debt and equity characteristics. 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 US$17bn (€15.76b) 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," Matellán said.
Daniel Sancho, head of investments at MAPFRE Inversión, added that it may be possible to find investment opportunities given the increase in AT1 spreads due to higher perceived risk in recent days.
Matellán does not see contagion spreading in the financial system currently, as this will require a failure of confidence both in banks with problems and those without, leading to liquidity being withdrawn from both equally.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," Matellán added, noting that many banks 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 capitalised than before. The question is whether they are sufficiently capitalized to absorb those losses."
With central banks seeking to avoid sending a message of panic to the market. Matellán said he believes that it is 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 is 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."
