Credit Suisse: Bondholders Left Empty-Handed While Equity Holders Get Paid

The details of UBS’ (NYSE: UBS) hastily arranged March 19 acquisition of Credit Suisse (NYSE: CS) could introduce even more unwanted uncertainty into the international banking system. The Swiss financial regulator Finma, which arranged the deal, called for the complete write-off of US$17 billion of Credit Suisse’s additional tier 1 (AT1) bonds. 

At the same time, Credit Suisse’s equity holders, who are junior to the AT1 bonds in the financial firm’s capital structure — meaning they should receive nothing unless all senior obligations are paid — will recover US$3 billion of value.

Finma apparently prioritized paying Credit Suisse’s shareholders something over a partial payment to these bondholders, a decision in direct opposition to financial convention. However, the Swiss government chose to overlook this inconvenience. Finma’s stated reason for its action was that it did not want to saddle UBS with any new AT1 liabilities.

AT1 bonds were introduced around 2009 in the wake of the Financial Crisis. AT1 bonds, also called contingent convertible bonds (CoCos), generally carry high yields, have no stated maturity date, and are the most junior type of bank debt. CoCos have both bond and stock characteristics and were designed to bolster a bank’s capital according to regulations designed to prevent failure. A bank can convert CoCos to equity if its capital falls below specified levels.

Looking to the future, the Swiss government’s decision introduces tremendous uncertainty into the US$275 billion global AT1 market, and at least some uncertainty into the overall bank bond market. In simple terms, the Swiss agreement may have effectively ended other banks’ access to a US$275 billion AT1 funding market.

In turn, bank treasurers will have fewer capital raising options during times of market stress. Indeed, the deal seems to set a precedent that if a bank in another country experiences financial difficulties, its CoCos could perhaps be written off as well to preserve some value for favored equity holders.

Similar unfair treatment has happened before in Europe, albeit on a much smaller scale. In 2017, Spanish regulators forcibly wrote off US$1.45 billion of CoCos issued by Banco Popular SA when Banco Santender SA acquired the teetering bank to avoid a collapse. In that case, Banco Popular’s equity holders received no recovery.

After the recent regional bank collapses and bailouts in the U.S., which have introduced fears about the soundness of the U.S. banking system, another event which injects additional fear was probably the last thing investors wanted to see. Unfortunately, the Swiss government created such an event with the details of the Credit Suisse-UBS deal.

Information for this briefing was found via Edgar and the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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