Crises have a tendency to shine a light on what, to laypeople anyway, are esoteric corners of the market. I think that’s a silver lining. Everyday investors are compelled to expand their horizons.

On Monday, AT1s made an exceedingly rare cameo above the proverbial fold, and even made their way into a handful of broader mainstream media coverage (i.e., outside of the financial media sphere). That was courtesy of Swiss authorities’ decision to wipe out one class of creditor as part of a shotgun marriage between UBS and Credit Suisse.

As I put it, “The Swiss might’ve killed the CoCos.”

Nomura’s Charlie McElligott weighed in with a characteristically incisive take on the fallout from the wipeout, if you will.

“Ironically, instead of helping to absorb and isolate losses on bank distress by acting an additional buffer of capital between shareholders and bondholders, the treatment of the AT1s in this case actually helped spread crisis contagion to the broader EUR banks through the sudden repricing the $275 billion AT1 perpetual bond space,” he said.

I flagged this on Sunday afternoon and then again on Sunday evening in a social media post which I promptly deleted, as is my wont. (As far as I can tell, the only thing I agree with Michael Burry on is the desirability of deleting tweets as soon as a few people read them.)

McElligott continued: “AT1s were created to do just this after the last euro banking crisis — [they’re] a vehicle for banks to raise capital at times of stress via a callable security which offered higher yield due to its subordinated nature, but one which could absolutely take a hit on a bank failure and impose losses on creditors and avoid hitting taxpayers first.”

He pointed to the iTraxx subordinated financials index. At the extremes Monday, the index was 45bps wider, although it eventually calmed down.

“This is yet another negative consequence of the past ‘bad’ behavior of central banks, as it was their very own experimentation with negative interest rates and perpetual large-scale asset purchases and market activism which incentivized the pursuit of, and demand for, AT1s from yield-starved investors,” McElligott said, providing some big-picture context.

Speaking further to the perception of risk, if you use Monday’s wides, and take the net spread widening in the SubFin CDX index on a seven-session basis (i.e., to capture the entire period from the SVB implosion through Credit Suisse’s existential week and then the CoCo wipeout), the rapidity of the move has just one precedent: COVID.

A more straightforward way to look at is just the simple figure above, which shows the index has suffered a trio of COVID-esque, single-session widening episodes over the past week (and, again, I’m using Monday’s wides).

Charlie went on to deliver the 30,000-foot view for banks and financials, which I think it’s very important to grasp. “This ‘latest and greatest’ iteration of global bank funding stress now further substantiates the larger ‘profitability / solvency’ crisis I’ve been speaking about recently,” he wrote. Then, he spelled it all out in straightforward terms:

Too flat curves / higher cost of capital / wider credit spreads = “negative carry” = NIM compression; a future state of enhanced regulation and forced capital raises; and all against structural dynamics which likely see a continued deposit flight, with too-low deposit rates, as customers are instead incentivized to continue shifting them into money market funds and bills offering magnitudes higher premium. So, a two-tiered US banking system, split between (long) GSIBs / SIFIs and (short) regional banks, in a placeholder back-book pairs trade.