May 18, 2018

Z Investment Management in the news: HFM article on launch of new founder share class

Joanne Bell

Jonathan Zenios was recently interviewed by Sam MacDonald of HFM about the business and the laugh of the new founders share class for the Z Special Opportunities Fund.

Full article and link below:

Former Barclays Capital head of structured capital markets Jonathan Zenios’ firm Z Investment Management (ZIM) has launched a founder share class of its financials credit strategy.

The new share class in Z Special Opportunities (ZSO) fund will be limited to $60m through a subscription period running until May next year.

ZSO is a financial sector-focused credit hedge fund that seeks to generate returns from relative value, soft event and trading strategies. It launched in July 2015 with internal assets and a small number of external investors.

The founder class carries an annual management charge of 1.3%, a 15% performance fee, a $5m minimum investment and a nine months’ redemption notice period.

“We have been focused on getting the team in place and building out the investment strategy and in the last few months we have become ready to raise assets,” said Zenios.

ZSO aims to tap into an investment universe of some $2trn of subordinated paper, including debt and preferred stock, with the strategy focused primarily on building a leveraged portfolio of bank capital instruments.

Zenios established the firm in March 2012, having previously been global head of structured capital markets and a member of the global partnership committee at Barclays Capital.

CIO Carmina Cortés joined as a partner and portfolio manager in February 2016. She formerly spent more than five years at Barclays in the structured capital markets team, and more recently held the role of Iberia Treasurer.

CEO Graham Wade joined as CEO in April 2015, having succeeded Zenios as Barclays’ global head of the structured capital markets until its closure in 2013.

In March, ZIM appointed ex-Merrill Lynch capital markets managing director Richard Klein as MD responsible for capital raising and investor relations.

Sam Macdonald

December 19, 2017

Brexit, ring-fencing and challenges for global banks in a Balkanised world

Graham Wade

Over the course of the last twelve months there have been increasing signs that the largest banking groups are well on track to achieve their long-term target capital levels.1

This is good news and consistent with our view that bank balance sheets have significantly de-risked such that a bank-led financial crisis is very unlikely in the short run.

However, we have been examining a key post-crisis theme of Balkanisation which we believe highlights a much sharper differentiation between the prospects for the top tier banking groups and the also rans. Furthermore it also highlights the benefit of being able to operate in a simple legal structure.

Balkanisation is a term used to describe the impact of a variety of regulatory changes which demand more capital to be locked up in the jurisdiction in which the relevant business activity takes place. This can take many forms. For example:
• ring-fencing in the UK
• new holding company requirements for non-US banks operating in the US
• similar requirements proposed for Europe
• consumer protection rules requiring that marketing of product can only be undertaken by local regulated banks; or
• exchange control rules in emerging markets.

This week you may also have seen discussion on whether the withdrawal of EU-passporting means that European banks will need to create UK subsidiaries to continue to operate in London – the flip side of the more obvious concern about UK banks operating in Europe post-Brexit.

We consistently believed that the dramatic increase in these requirements was going to be a major headache for certain banks and one of our common investment themes is that markets do not fully understand the consequences of Balkanisation.

Specifically, we have been studying how the limitations on deploying and repatriating capital will impact traditional diversification effects. Historically, the allocation of capital from one business to another was mainly an internal accounting process fully within the control of the bank’s executives. However, as banking groups become siloed, there are now legal restrictions, delays and the need for regulatory approval preventing the free movement of capital from one part of the group to another.

We have analysed the volatility of quarterly returns (RoE) for a group of the top 30 global banks over the last 10 years. We grouped the 30 banks into three peer groups based on their post-crisis volatility of RoE (the top peer group had an average standard deviation of quarterly RoE of 2.7% compared to the bottom group which had 10.3% standard deviation).

We assumed that the volatility trends will continue but we assumed that all of the banks would generate an average return on equity of 8% in the coming years (in line with what the top tier groups have generated since the start of 2016 – a very generous assumption for the bottom tier group as we will explore in a forthcoming article).

Using these assumptions, we ran Monte Carlo simulations of the capital position of a hypothetical two-subsidiary banking group and compared to an identical bank which can operate on a fully integrated basis.2

The following chart shows the probability that the simulated banks with return characteristics of the different peer groups would exceed their capital buffers over the course of a year if operated in two groups or as a single entity.

Whilst we expected this to be an issue for certain banking groups, we were surprised by how stark the differentiation is.

Whilst this may sound obvious, the best run banks with the lowest volatility of returns have major competitive advantage. They can run safely with significantly lower capital buffers. A bank with low volatility of returns can run 1-2% lower capital buffers than its more volatile competitors and this would mean a RoE outperformance of c8-17% (ie RoE of 8% vs 6.9% for its more volatile peer) all other things being equal.

Equally the effect of operating across two subsidiaries is a major drag on returns. To operate with a similar likelihood of consuming capital buffers a two-entity group would need 1-2% higher level of capital buffer compared to an equivalent fully integrated group.



  1. For example the recent Bank of England Stress Tests included some large economic shocks and all banks passed the test.
  2. We have necessarily had to make some other significant simplifying assumptions. For example we have assumed that bank quarterly RoEs are normally distributed. Whilst this is almost certainly not true in practice our analysis going back to the end of 2008 shows that, as a group, the returns are actually very close to normally distributed with a moderate fat tails on the downside.
  3. We have also assumed that banks’ different business units profits are 50% correlated with each other – an examination of this is well beyond the scope of this article but what academic evidence there is suggests that the returns across different business lines do have a degree of correlation. We also ignore the fact that returns of a given bank are likely to be auto-correlated. Adjusting for this would increase the winners vs losers effect of the results.
  4. Underlying data was sourced from CreditSIghts
  5. Some other observations we draw from this analysis are:  
    1. Large retail franchises in each subsidiary are a significant benefit as they have historically reduced volatility meaningfully
    2. The effect is the biggest issue for banks where the various subsidiaries are of similar sizes or material in absolute terms. Whilst a bank with large operations in one country and much smaller in another would have some impact from these effects they are likely to be manageable within the overall group buffers.
    3. We have modelled based on the assumption of RoE being the only variable and balance sheets remaining static. Banks will always operate with some capital buffer and in practice have a range of management actions they can take to manage short falls but none of these are easy or costless (eg sell assets, reduce trading risk, cut costs etc).

October 10, 2017

How global regulation has created brand new investment classes already approaching $2 trillion in value

Jonathan Zenios

The introduction of the Basel 3 reforms has resulted in significant changes to the way banks fund themselves including the types of instruments issued. Why should markets care and what does this mean? As a result of these regulations entirely new asset classes have emerged known as Additional Tier 1 (AT1 or so called ‘CoCos’) and Tier 2. These instruments are subordinated to senior bank debt providing a yield pick-up but are senior to common equity allowing for lower volatility.

Currently there are over $1.8 trillion in instruments outstanding globally – double what was outstanding in 2013 when the reforms came into force and 10x pre-crisis levels in 2006 when total issuance was just under $160 billion. In comparison there is around $8 trillion currently outstanding in publicly traded common equity from banks. End state for a typical well capitalized bank is c. 8-10% equity, 1-2% AT1, 2-3% Tier 2 and issuance levels reflect banks getting to this as BIS fully loaded ratios come into force.

A tenfold increase in the amount of securities issued since the crisis hasn’t gone unnoticed. More and more investors are looking at AT1 and Tier 2 instruments for diversification, a Morgan Stanley survey of European investors outlined that 63% of respondents described their AT1 holdings as a core part of other long-term holdings[1]. This also isn’t just CoCo or pref share funds, over 60% of AT1 volume holders in the survey are asset managers – most of which are not primarily HY focused.

This result shouldn’t be surprising, financials are arguably better capitalized than ever[2]. The deleveraging of banks will continue as capital requirements are phased in at fully loaded levels – further reducing balance sheet sizes which should also be good for debt investors. Whilst the low interest rate environment has not helped banks achieve their ROE targets, with the exception of some of the weaker or periphery banks this is primarily an issue for equity holders rather than having a meaningful impact on solvency.

In the high yield corporate bond market, subordinated instruments ranked similarly to AT1 and Tier 2 make up around $1.2 trillion outstanding. Interestingly it appears ghosts from 2008 are still in the mind of the market, where there’s a significant yield pick-up for financials – total return levels are c. 2x higher for the European CS CoCo index vs European high yield corporate credit with the same average credit rating[3].

On all measures of risk and liquidity banks are much safer holding substantially more capital on lower risk balance sheets. Regulators are also playing an active role (e.g. in clarifying rules on coupon payment priorities) and are determined to make the new AT1 and Tier 2 asset classes a success. This is resulting in an interesting relative value assessment versus traditional HY corporate and bank equity markets – investors are taking notice.

[1] Morgan Stanley European Banks 2017 AT1 Survey – Results, 5 May 2017.
[2] Bank Capital. Mini-skirts and Maxi-dresses
[3] Credit Suisse, European Banks: Attractive Relative Value, 06 September 2017.
General: market data from Bloomberg 26 Sept 2017.

August 28, 2017

Are some banks at risk of drowning in the NSFR river?

Graham Wade

Whilst the Net Stable Funding Ratio (“NSFR”) is not a big deal for the overall banking industry, certain business lines may have more challenges than the market anticipates.

The NSFR is one of the core planks of the post crisis regulatory reform (Basel 3). It requires banks to maintain a much more stable mix of funding than was the case before the crisis.

The reliance on short term wholesale funding that was exemplified by Northern Rock in the UK and Washington Mutual in the US will not be permitted.

In basic terms the NSFR requires banks to apply a stability factor to all of its assets and its funding sources and then ensure that its stability adjusted funding is sufficient to cover the liquidity profile of its assets. In general the rules aim to ensure the banks can weather 12 months of challenging funding conditions.

All funding with a maturity longer than 12 months is consider stable. For shorter dated funding the rules are intended to reflect behaviour observed in liquidity crises. For example retail deposits are considered to be very stable whereas wholesale funding is considered very flighty.

There is a lot of good sense in the NSFR and, coupled with the Liquidity Coverage Ratio (LCR) which ensures banks have cash to cover the next 30 days, our view is that there will be a dramatic reduction in the risk that a major bank gets caught in a liquidity squeeze.

However, as with all formula based rules there are some unusual features and cliff edge effects. As the following chart (EBA Dec 2015) shows there are also some clear policy choices that have been made in designing the rules. For example, a traditional retail deposit funded mortgage bank will have very few problems with NSFR which seems reasonable. However repo funding and derivatives are badly impacted even where there is no real liquidity risk created by the bank’s business. These two aspects largely explain the difference between the banks which comply and those with shortfalls.

The official line both from the regulators and most of the large banks is that NSFR is not a big issue and that they are already largely compliant ahead of implementation. Much of this confidence is based on industry studies by the ECB and Federal Reserve. For example in its December 2015 report which confirmed that the EBA is in favour of the NSFR the EBA cited the average NSFR was 104% (vs a 100% requirement).

This reminds us of the famous investment advice that a six-foot man can drown in a river which has an average depth of three feet.

Banks that have outsized prime or securities financing business are likely to be heavily impacted and the report also ignores the painful impact that UK ring-fencing will have (and similarly the equivalent Dodd-Frank and proposed European holding company rules).

The industry and consolidated banking groups will be fine but particular subsidiaries could find themselves with NSFR being a binding constraint causing them to further reduce balance sheet and client footprint. We have calculated that the marginal cost of balance sheet for an NSFR constrained bank will be in excess of 100bps precluding many low risk forms of financing.

July 31, 2017

Bank Capital: Mini-Skirts and Maxi-Dresses

Jonathan Zenios

When I was at school in the 1980s each time we were set an essay, some bright spark would invariably ask how long should it be. To which the (of course, male) teacher’s response invariably was:

An essay should be like a woman’s skirt – long enough to cover all the essentials but short enough to be interesting.

As for essays of the 80s so for bank capital requirements of the 00s.

Legend has it that this approach to essay writing was taken to its logical extreme in the Oxford University general entrance paper when an aspiring student’s answer to title “What is bravery???? was the one liner “This is???. No doubt this had the desired effect for the first student who used it, but you wouldn’t fancy the chances of the second one to try it.

For the world’s largest banks the extreme point was reached in 2008 when RBS supported a £2.4 trillion balance sheet with a Tier One ratio of 6.1%. Too short to cover anything but certainly interesting if only in a bad way.

While most of us end up feeling nostalgic about our schooldays whether or not we actually enjoyed them at the time, few people miss the financial crisis.

Things have changed a great deal for the world’s largest banks since 2008 and generally in a good way. For starters while still large they are all a lot smaller than they were – RBS’s 2016 balance sheet was one third the size of its 2008 one and its CET1 ratio was over 13%. They also make a lot less money than they used to but are much less likely to lose lots of money in the future (even if some, such as RBS again, are still over a decade later paying the price for past excess).

Regulatory change has forced banks to deleverage, narrow their focus, fund themselves in more stable ways and hold a lot more capital. They are undoubtedly safer and more boring or to put it in a way my English teacher would understand – more maxi-dress than mini-skirt.

  • Note 1: RBS reported figures – 2016 under BIS III; 2007-2008 under BIS II on a proportionally consolidated basis
  • Note 2: FSB study estimates CET1 ratio of 1.97% at end 2007 under BIS III rules