Adviser Commentary: Bank Update

Adviser Commentary: Bank Update

Over the past two weeks, the preferred and contingent capital securities market has been roiled by the liquidation of Silvergate Capital Corp, and the receiverships of Silicon Valley Bank and Signature Bank NY. On March 19, Credit Suisse Group was taken over by UBS Group at the behest of Swiss bank regulators and included a full write down of CS's contingent capital ("CoCo" or additional tier-1 [AT1]) securities. These events were triggered by deposit withdrawals straining the banks' liquidity, despite strong regulatory capital positions at each of these banks.

While it is still very early in these resolutions, in the case of the U.S. banks, the normal priority of losses will apply, with common equity absorbing losses first, followed by preferred securities, subordinated debt, and more senior claims thereafter. The Credit Suisse situation was different: common shares received CHF 3 billion of UBS common stock, while its CoCos received nothing. Although the terms of the securities appear to give Swiss regulators that authority, it was a shock to the broader CoCo market and led to sizable declines in market prices there today. In response, both the European Central Bank and the Bank of England made clear statements that CoCos in their jurisdictions rank ahead of common equity and behind tier-2 capital (a form of subordinated debt), prompting a partial recovery of earlier declines. Among jurisdictions in which the Funds have purchased CoCos, Switzerland's approach to "bail-in" is unique.

Central banks have extended significant liquidity to banks to accommodate deposit outflows or other liquidity needs. In addition to the discount window, which accepts a broad range of collateral, the Federal Reserve established a new Bank Term Funding Program that allows borrowers to pledge certain collateral at par value without "haircuts" to market value that apply at the discount window. Borrowing from these facilities expands the Fed's balance sheet and enhances overall bank liquidity. In addition, the Federal Home Loan Bank system continues to provide funding against mortgage collateral.

Investors have expressed concern over regional bank deposits. We note that regional banks have consolidated, diversified, and grown their deposit and loan bases significantly since the 2008-09 financial crisis. They are often the go-to banks in their regions.

As of year-end 2022, U.S. banks' regulatory capital levels remained strong and loan quality was high. Non-performing loans and charge-offs were historically low, and the ratio of loan-loss provisions to non-performing loans was at a record high.

March 20, 2023

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It is difficult to predict when greater stability will return to bank's deposit positions and to the preferred market, and we cannot rule out additional bank failures. Banks likely will need to raise the interest rates they pay over coming months to retain deposits. That would reduce net interest margin (NIM) earned by banks, which expanded significantly in 2022 as interest rates on loans outpaced that on deposits with the Fed rapidly raising short-term rates. We expect higher deposit rates to be an earnings headwind in 2023-but not a threat to financial stability.

Flaherty & Crumrine Incorporated

Additional Information:

The following table shows each Fund's U.S. regional and community and non-U.S. AT1 CoCo bank exposures as of February 28, 2023, including issuer-level exposures on the four banks discussed abvoe. The Funds owned positions in Credit Suise, Silicon Valley Bank, and Signature Bank at the time of acquisition or FDIC receivership, as applicable.

as of 2/28/2023	PFD	PFO	FFC	FLC	DFP
Silvergate Capital Corp	0.0%	0.0%	0.0%	0.0%	0.0%
Silicon Valley Bank	0.4%	0.3%	0.7%	0.3%	0.3%
Signature Bank NY	0.3%	0.4%	0.4%	0.4%	0.4%
Credit Suisse	1.0%	1.0%	1.1%	1.0%	1.0%
U.S. Regional Banks	16.3%	15.8%	16.4%	15.3%	16.0%
U.S. Community Banks	5.1%	5.2%	5.1%	5.0%	5.0%
Non-U.S. AT1 CoCos	16.7%	16.7%	17.1%	20.3%	16.5%

This commentary contains forward-looking statements. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast; the opinions stated here are subject to change at any time. The information contained herein has been obtained from sources believed to be reliable, but the Fund does not represent or warrant that it is accurate or complete. The views expressed herein are those of the Fund and its Adviser and are subject to change without notice. The securities or financial instruments discussed in this report may not be suitable for all investors. No offer or solicitation to buy or sell securities is being made by the Fund.

March 20, 2023

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