Can Limited Recourse Capital Notes Be Wiped Out in Canada à la Credit Suisse?

DBRS Morningstar published a commentary discussing the differences between the limited recourse capital notes (LRCNs) issued by Canadian banks and insurance companies and the AT1 notes issued by Credit Suisse. The commentary explains why Canadian LRCNs will not function in the same manner as the Credit Suisse AT1s in a default scenario and what the implications are for investors.

Key highlights include the following:

-- LRCNs issued by Canadian financial institutions differ from the AT1s issued by Credit Suisse in key ways, including how the trigger point is defined as well as the events that take place once the trigger event has occurred.

-- In a situation where default is imminent, insurance LRCN investors will rank pari passu to preferred shareholders. Bank LRCNs will see a conversion to common shares in a manner that maintains the credit hierarchy and where LRCN investors are expected to rank in priority to common shareholders.

-- While we see no change in the fundamental risk of Canadian LRCNs, investor appetite will likely be limited in the near future as investors seek higher ranking debt in light of recent bank failures and the current period of heightened volatility.

“Given the current sound financial state of Canadian financial institutions that have issued LRCNs, we consider the possibility of a non-viability trigger event occurring to be fairly remote,” said Komal Rizvi, VP, Insurance. “However, in light of recent bank failures globally, investors will likely demand higher yields on debt securities, particularly deeply subordinated LRCNs, or reduce their exposure to lower rated debt instruments in general, with Canadian financial institutions likely to face a temporary freeze in LRCN issuances and higher debt funding costs.”