How’s this for a great illustration of the importance of active management in fixed income? It was February 6th and Credit Suisse was hosting their earnings call after having issued their results earlier in the morning. Their chief financial officer, David Mathers, was providing commentary on the disclosed results, which saw profits miss consensus estimates and decline 41% versus the prior quarter. Almost 50 minutes into a call that would last two hours and thirteen minutes, Mathers said something that caught the market off-guard.
After finishing a brief comment regarding their capital levels Mathers said this,
Just finally, I think, obviously I think you know that we redeemed the first tranche of the Claudius notes in December 2013. And I would like to note that we are currently reviewing options to potentially call the second and the final tranche at some point during 2014.
Seems innocent enough, right? Well, based on Mathers’ comments, the security dropped from a price of US$107 down to around US$102. Why did the price drop? The comment caused the market to fear that Credit Suisse would use the “Regulatory Event” language contained within this issue’s terms and conditions. Without getting too deep into the legal mumbo-jumbo, the language basically allows them to call the security at par (or $100) if they have determined that a regulatory event has occurred. Based on new regulations that have been implemented since the financial crisis, securities that previously counted toward a bank’s regulatory capital are now ineligible. That means that many banks are redeeming the securities that are now viewed as “expensive” funding.
However, as you might imagine, calling the security at par would leave a pretty bad taste in the mouth of investors. In an effort to try to save face, many firms have conducted what is called “above market tenders,” where they basically give investors a dollar to two more than where the security is currently trading in the market. So what do you think Credit Suisse did a mere eight days later? They offered to buy the securities from investors at $103. In the event investors chose not to participate in this buy-back, the firm threatened to use the regulatory event language to take the security out at par ($100). Unfortunately, if you owned this security, you’re obviously not very happy; Credit Suisse’s comments just drove the price down from $107 to $103. But you’re basically forced to take the $103, because if you don’t they’ll force you to take $100 later. Nice, right? Well, maybe not for investors, but Credit Suisse is pretty happy about it.
We think this example provides a terrific example of why it’s important to have a deep understanding of each individual security, and to keep your finger on the pulse of the changing regulatory landscape. And, frankly, it’s an example of why active management of a fixed income portfolio is so important. In a buy-and-hold or indexed strategy, an investor would have just lost US$4 as a result of these actions.
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