The acquisition of Credit Suisse by UBS and its implications for the wider European banking sector and indeed for financial markets generally is going to be a fast-evolving story this week. As of Monday afternoon, one of the key points of focus were the Credit Suisse AT1 bonds.
One of the key tenets of investing has been that creditors of a company – i.e. bond holders – usually take priority over equity holders under circumstances where a company – or bank – is going under. The Additional Tier 1 bonds – AT1 – issued by Credit Suisse came about because banks and regulators wanted an instrument that could be quickly converted into shares in the event of another financial crisis (these were dreamed up after the last big banking blow up in 2008).
These bonds are also called co-co bonds – standing for ‘contingent convertible.’ Banks liked them because they could be used as part of their Tier 1 capital accounting. As of the end of Q4 last year, Credit Suisse had CHF 14.7bn in AT1 bonds on its books. This was being measured against its capital requirements.
AT1 bonds are not the same as other bonds
Investors in Credit Suisse AT1 bonds last week were working on the assumption that if UBS was to buy Credit Suisse over the weekend, credits, including AT1 bond holders, would still see some kind of payout before shareholders got anything. but it now seems there is a legal basis to write off the AT1 bonds because they are not, at least as far as the Swiss regulator is concerned, actually proper bonds. Or at least that’s my reading of it.
It now seems as if national regulators can, in moments of crisis, write these bonds off. The value of the total amount of AT1 bonds being written off is hard to deduce accurately, due to the complexity of the Credit Suisse organisation, which we have written about before. But one figure we’ve seen is CHF 16bn.
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Implications for European bond investors
One of the broader issues is that Credit Suisse is obviously not the only bank with AT1 bonds out there. We have a lot of investors holdings these bonds with other banks who are now starting to feel nervous. European regulators are not happy with the way the Swiss regulator has moved to write these off as part of the UBS deal. The full European AT1 bond market is estimated to be over EUR 250bn. Just the UBS deal stands to be the largest write off of AT1 bonds since they were created, dwarfing the write off of Banco Popular’s EYR 1.35bn AT1 issue in 2017.
But the important factor here is that the bond holders are being put in the queue behind the stock holders by the Swiss. Shareholders are being paid out to the tune of USD 3bn. AT1 bond holders will seemingly get nothing.
The original intention for AT1 bonds has always been that they stack up after any losses are absorbed by common equity tier one capital. Investors were selling these bonds hard on Monday afternoon as the realisation sank in that they are not being treated – at least by Swiss regulators – as the same as other debt. Fund managers are now anticipating a crazy week of trading ahead.
Other central banks like the Bank of England and the ECM moved on Monday to reassure AT1 bond holders that “…common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down”. However it does seem as though lawyers and investors are not happy with how Swiss regulators have moved on this. The Invesco AT1 Capital Bond UCITS was down 6% mid-afternoon on Monday. It can be viewed as a proxy for the AT1 market.
We know of at least one law firm – and there are no doubt many more – that have already put together multi-jurisdictional litigation teams to represent investors in Credit Suisse AT1 instruments. This includes firms which worked on the litigation arising out of the sale of Banco Popular to Banco Santander in 2017.
