Only time will tell whether UBS ends up ruing or celebrating its swoop for Credit Suisse, but the biggest losers of a wild weekend are undoubtedly investors in CS’s AT1 bonds.
Additional Tier 1 bonds are a creature of the post-financial crisis regulatory architecture for Europe. In addition to carrying far more plain equity, big banks were forced to issue “contingent convertible” bonds that could be quickly transformed into more equity or just wiped out in a crisis, and thereby hopefully make a taxpayer bailout less likely.
The most common form of these CoCo bonds are just known as AT1, because their design means that banks can count them towards their overall loss-absorbing tier one capital. TwentyFour Asset Management has an excellent explainer.
Credit Suisse issued a big fat chunk of them in the past decade. Here is a presentation that Credit Suisse gave to investors last week as it was battling to save itself, which says it had SFr14.7bn of AT1 bonds outstanding at the end of 2022.
Credit Suisse’s AT1 bonds were taken to the woodshed last week as fears about its financial health exploded, but this Sunday they actually rallied hard — from a lows of 20-40 cents on the dollar to 50-70 cents according to Bloomberg — as hopes grew that the UBS takeover would see them shielded.
After all, if UBS was paying Credit Suisse shareholders $1bn $2bn $3bn then surely the AT1s would be shielded? They couldn’t possibly give the equity at least a consolation payment and fiddle with creditors — even if they are. the most junior creditors possible? Surely?
Are private creditors of Credit Suisse also exposed to the risks of the takeover?
Yes. FINMA has been provided with a clearer legal basis so that part of Credit Suisse’s regulatory capital can be written off (private creditors are to share in the exposures to the tune of around CHF 17bn). This ensures that private measures are taken in addition to state measures.
WHOOPS. Clearly the Swiss regulators looked at the instruments and felt confident that they have the legal backing to vaporise the AT1s. The standard threshold is when Common Equity Tier 1 falls below 7 per cent, but we think they can often be triggered at a national regulator’s discretion — basically when they reckon a bank is “non-viable”.
A separate Credit Suisse press release puts the value of AT1 bonds being wiped out at CHF16bn. We’re not sure what explains the discrepancy with the Swiss government statement and last week’s presentation, but it’s probably related to different parts of the CS sprawl, with some bonds issued by the holding company and others by different subsidiaries.
What is clear is that this was a swift nuking of Credit Suisse’s AT1s. Beyond the immediate pain for the holders, we suspect this is going to be viewed . . . unfavourably by investors in the broader European AT1 market.
Now, getting zeroed at times of criss is obviously the whole point of these securities, and it’s easy to see why the Swiss decided to do this. It will make CS far easier to swallow for UBS without indigestion. Legally, we’re sure Finma and the Swiss National Bank are fine.
But sometimes the legal niceties matter less than the optics — especially in stressed markets. And bondholders really care about being behind equity when then pain is being distributed.
Europe’s AT1 market is about €250bn, and this is the biggest wipeout since it was born. The only other example is Banco Popular’s €1.35bn AT1 bond vaporisation in 2017 — but in that case the equity was also zeroed.
So while the Swiss authorities may hope that the CS takeover will draw a line under the matter they (and others) might rediscover how contagion works on Monday morning. As one of FTAV’s favourite financials guru said on Twitter.
CS confirms shareholders will get 3bn and AT1 holders 0. This won’t go down very well as it’s an obvious breach of the hierarchy of claims
— JohannesBorgen (@jeuasommenulle) March 19, 2023