Why $17bn in Credit Suisse debt was wiped out

Two things to start: First, the Financial Times’ Stephen Morris and Due Diligence’s James Fontanella-Khan and Arash Massoudi give a blow-by-blow account of UBS’s historic rescue of Credit Suisse in this Big Read.

The takeover will result in tens of thousands of job cuts at Credit Suisse, with its domestic unit and its investment bank taking the biggest hit, according to people familiar with UBS’s plans.

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In today’s newsletter

  • The Swiss go cuckoo for cocos

  • BlackRock’s warning to SVB

  • Casino plays deal roulette

Credit Suisse: don’t go chasing waterfalls

Over the weekend we saw the most consequential bank deal since the 2008 financial crisis.

UBS agreed to buy its rival Credit Suisse for $3.2bn in a deal engineered by Swiss regulators to save the country’s second-largest bank.

But the “real plot twist”, as one trader put it, came as investors that hold CS’s additional tier 1 (AT1) bonds were entirely wiped out as part of the deal.

Line chart of Invesco AT1 bond ETF net asset value ($) showing Additional tier one bond prices tumble

Losses aren’t unusual in times of distress. AT1 bonds, also known as contingent convertibles or “cocos”, were introduced after the financial crisis of 2008 to strengthen bank balance sheets and avoid bailouts funded by taxpayer money.

They’ve since exploded into a $260bn market and become a critical piece of the capital structures of European banking giants such as Deutsche Bank.

What’s unusual, however, is that shareholders are walking away with $3.2bn while bondholders receive nothing. In situations like this, there’s something called a loss absorption waterfall, or a hierarchy of claims. Equity is almost always wiped out before bondholders are taken to zero.

Investors in the debt have been outraged by the move from Swiss regulators, with some claiming the decision is illegal. Law firm Quinn Emanuel Urquhart & Sullivan said on Monday that it’s in talks with a large block of debtholders about possible legal action.

To make matters worse, CS told employees that it will continue to hand out bonuses and pay rises as planned this year, despite being saved from the brink of bankruptcy.

On the face of it, it appears to be a pretty big infraction by Swiss regulators — there’s a pecking order and people are expected to follow it.

But unless you’re talking to bondholders themselves, the rest of the market seems to be pretty unsympathetic.

That’s mainly because AT1 bonds are known to be risky, hence why some CS AT1 bondholders were getting yields of 9.5 per cent. The offering documents made no assurance that equity would get wiped out first, or that terms are standard across jurisdictions. Indeed, a contractual provision states AT1s can be written down if the issuer, in this case CS, is deemed “non-viable”. 

This could all end up being debated in court. Lex notes that the debacle raises questions over how effective AT1s are for their intended purpose — bolstering balance sheets.

On Monday, the FT team that broke every big story on UBS/CS got to the bottom of the AT1 “plot twist”.

They were slaughtered in order to make CS shareholders happy to receive any return.

“AT1 holders were sacrificed so the finance ministry could try to save some face with international equity holders after denying them a vote on either side of the transaction,” a banker advising on the takeover told the FT.

Inside BlackRock’s warning to Silicon Valley Bank

Before its collapse this month, Silicon Valley Bank had been warned by the world’s largest asset manager that its risk controls were poor.

BlackRock’s consulting arm warned SVB, the lender whose failure helped spark a banking crisis, that its controls were “substantially below” peers and lagged competitors in almost every facet, DD’s Antoine Gara and Brooke Masters report in an explosive scoop.

SVB hired BlackRock’s Financial Markets Advisory Group to study its risk controls and received a “gentleman’s C” in a brutal assessment delivered to the bank’s top brass in January 2022.

SVB lagged behind similar banks on 11 of 11 factors considered and was “substantially below” them on 10 out of 11, said people familiar with the matter. It was also unable to generate real-time or even weekly updates about what was happening to its securities portfolio.

Instead of sounding alarm bells inside the bank, the assessment was largely ignored. SVB listened to the criticism but rebuffed offers from BlackRock to do follow-up work.

SVB’s collapse is now the subject of a Federal Reserve review led by Michael Barr, its vice-chair for supervision. The Federal Reserve Bank of San Francisco, where SVB chief executive Greg Becker was a board member, also found risk deficiencies, The New York Times reports.

BlackRock’s review also missed an opportunity to correct course on SVB’s catastrophic decision to build a $91bn securities portfolio of long-dated debts.

In October 2020, BlackRock analysed how SVB’s securities portfolios would respond to factors including rising interest rates.

But the review used inputs selected by SVB and studied rate increases of just 1-2 percentage points. No models considered a scenario where rates went higher — as they ultimately did — or how that would affect its deposits.

BlackRock’s consultation concluded in June 2021. While no recommendations were made, the report was influential internally. It “confirmed the direction management was on” in buying long-dated assets carrying higher yields to bolster short-term profits, said one former SVB executive.

The former executive called it “an opportunity to highlight risks” that had been missed.

Casino makes another complex gamble for survival

There’s always another hand to play at the casino of Casino, the deeply indebted food retail group controlled by former star executive and noted financial engineer Jean-Charles Naouri.

Jean-Charles Naouri
Jean-Charles Naouri is part of a generation of French businessmen who have used complex financial engineering to build business empires via debt-fuelled acquisitions © Reuters

The 74-year-old executive is cooking up a complex deal that would merge Casino’s French food retailers with Teract, a company founded by his old business partner Moez-Alexandre Zouari and two prominent French businessmen via a Spac deal last year. It’s an effort to save what remains of his empire ahead of a wall of debt that comes due starting next year.

Not everyone is convinced, however, as shares have fallen by more than a quarter in the past month. One hedge fund manager who has been short Casino said the “half-baked deal announcement” was an attempt to distract from the group’s cash burn.

But the pair’s longstanding relationship may have made Zouari the only person who could convince Naouri to loosen his grip on Casino, said people close to the deal.

“Until now the other deals Naouri had to choose from were all going to hand him a loss,” Zouari told the FT, referring to previous suitors Carrefour and Auchan. “People don’t understand that he is not just a financier, he is very attached to the company he built.”

Job moves

  • Karen Miles, Credit Suisse’s head of high-yield trading for Europe, the Middle East and Africa, has joined Deutsche Bank as European head of high-yield trading in London.

  • Separately, Credit Suisse execution services executive Charlie Whitlock has joined algorithmic trading group XTX Markets as head of Americas distribution in New York.

  • InterContinental Hotels Group chief financial officer Paul Edgecliffe-Johnson has joined UK betting group Flutter as CFO.

  • Bank of America has named Mike Browne and Anand Melvani as co-heads of its leveraged finance business in the Americas. The bank also appointed Mike Hobby and Bhavik Pandya to lead the leveraged finance franchise in Asia Pacific, according to a memo seen by DD.

  • Klaus Hommels, founder and chair of European venture capital firm Lakestar, has been appointed chair of the Nato Innovation Fund.

Smart reads

Back on the stand Drexel Burnham Lambert wunderkind Terren Peizer stayed out of trouble by testifying against his former boss Michael Milken. Nearly two decades later, he’s at the centre of a novel insider trading case, DD’s Sujeet Indap writes.

How SVB f****d up Silicon Valley Bank trusted Goldman Sachs, and it got shot in the foot. Former Bank of America executive Craig Coben’s latest Alphaville post explains what bankers need to learn from the situation to avoid a similar fiasco.

The British are coming As he bids for England’s most storied football club, UK tycoon Jim Ratcliffe is considering charting his empire west, including the Texas oil patch, The Wall Street Journal reports.

News round-up 

Wall Street CEOs try to come up with new plan for First Republic (FT)

Bid deadline for failed Silicon Valley Bank is extended as buyers hold back (FT)

JPMorgan and Deutsche Bank must face Jeffrey Epstein claims, judge rules (FT)

UBS mulls sweeteners to keep Credit Suisse wealth bankers (Reuters)

EY told to give NMC Health administrators notice of break-up votes (FT)

Evergrande releases restructuring timeline (FT)

Brookfield buys out KKR’s stake in Spanish solar company (FT)

Rupert Murdoch engaged to be married for fifth time (FT)

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