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How the Credit Suisse rescue wiped out $17bn – and threatened the next crisis

FILE PHOTO: FILE PHOTO: Credit Suisse logo and decreasing stock graph are seen in this picture illustration taken March 16, 2023. REUTERS/Dado Ruvic/Illustration/File Photo/File Photo - DADO RUVIC/REUTERS
FILE PHOTO: FILE PHOTO: Credit Suisse logo and decreasing stock graph are seen in this picture illustration taken March 16, 2023. REUTERS/Dado Ruvic/Illustration/File Photo/File Photo - DADO RUVIC/REUTERS

The emergency takeover of Credit Suisse by rival UBS over the weekend leaves few obvious winners, but holders of its riskiest bonds are certainly among the biggest losers.

In a move that startled markets, the Swiss financial regulator Finma ruled that investors in $17bn (£13.9bn) of Credit Suisse bonds, known as AT1s, will have their investment wiped out entirely as part of the shotgun marriage between the country’s two biggest banks.

On Sunday, Finma said: “The extraordinary government support will trigger a complete writedown of the nominal value of all AT1 shares of Credit Suisse in the amount of around SFr16bn (£14.1bn), and thus an increase in core capital.”

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Yet the move raises questions about the hierarchy of investor claims, with Credit Suisse’s shareholders receiving $3.3bn as part of the deal, and risks sending the $275bn market for bank funding into chaos.

What are AT1s?

Additional Tier 1 bonds (AT1s) are a type of debt issued by banks that can be converted into equity if a bank runs into trouble.

They were introduced in the wake of the financial crisis in a bid to reduce the likelihood of taxpayer bailouts. Because the bonds carry the risk that investors can be entirely wiped out, they are inherently riskier to hold and, as a result, offer higher returns than safer bonds.

Charles-Henry Monchau, chief investment officer at Syz Bank, says: “AT1 bonds were introduced in Europe after the global financial crisis to serve as shock absorbers when banks start to fail.

“They are designed to impose permanent losses on bondholders or be converted into equity if a bank’s capital ratios fall below a predetermined level, effectively propping up its balance sheet and allowing it to stay in business.”

What happened with Credit Suisse’s AT1s?

On Sunday evening, Swiss regulators ordered that all of Credit Suisse’s AT1s, worth around $17bn, would be written down to zero.

Analysts at Goldman Sachs said the move “represents the largest loss ever inflicted to AT1 investors since the birth of the asset class post-global financial crisis”.

FILE- In this Sept. 15, 2008, file photo traders work in the product options pit at the New York Mercantile Exchange in New York. A decade ago, as Lehman Brothers went bust and the fragile financial system was teetering, fund investors wondered how bad it could get. The S&P 500 plunged 4.6 percent on Sept. 15, 2008 and would incur worse losses in the ensuing months. (AP Photo/Seth Wenig, File) - AP Photo/Seth Wenig

It came as a surprise to many in the market, as the “trigger event” for the bonds being written down was nowhere near being invoked as Credit Suisse’s capital buffers were still well above that trigger level.

John Cronin, a banking analyst at Goodbody, says: “Finma’s decision to effect a permanent writedown of the AT1 securities… has come as a shock to AT1 investors and is likely to see the AT1 market shut to new issuance for now.

“While solid arguments can be made around the risks having been there for AT1 investors to see (underpinning the high coupons on such instruments), the fact that ordinary equity investors are left with something while AT1 investors are extinguished is unprecedented.”

However, it has been pointed out that the threat of writedowns was clearly flagged as a risk when the bank was issuing the debt.

Issuance documents for one type of Credit Suisse’s AT1s pointed out that in the situation of a write-down event, the full principal amount will be written down to zero, holders will have irrevocably waived their rights to the repayment of the notes, and the notes will be permanently cancelled.

Why are markets worried?

Yet given the unprecedented scale of the writedown, the move has rattled global markets and sent similar debt tumbling in early trading on Monday.

Creditors have been left scrambling to assess the fine print of their AT1 holdings, in a bid to establish whether other countries could repeat what the Swiss government did over the weekend.

Concerns centre around the hierarchy of investor claims. Typically, AT1 bondholders rank above shareholders in the creditor pecking order. But Swiss regulators inverted that order on Sunday.

Chairman of the Board of Directors of Credit Suisse, Axel Lehmann, Chairman of the Board of Directors of UBS, Colm Kelleher and Federal Councillor and chief of the finance federal department Karin Keller-Sutter attend a news conference on Credit Suisse after UBS takeover offer, in Bern, Switzerland, March 19, 2023. REUTERS/Denis Balibouse - REUTERS/Denis Balibouse

Bond investors are furious. Patrik Kauffmann, a portfolio manager at Aquila Asset Management, who holds the notes, told Bloomberg: “This just makes no sense. Shareholders should get zero [because] it’s crystal clear that AT1s are senior to stocks.”

Jérôme Legras, head of research at Axiom Alternative Investments, also said: “Wiping out AT1 holders while paying substantial amounts to shareholders goes against all the resolution principles and rules that were agreed internationally after 2008.”

What happens next?

The decision to burn Credit Suisse’s AT1 holders leaves bond investors in uncharted waters.

Recognised as a key corner of funding for banks post-financial crisis, there are concerns that the market could effectively shut down as investors assess the fallout from Credit Suisse.

AT1s are a type of “contingent convertible” bonds, or CoCo, with fears now growing that the wipe out of Credit Suisse’s AT1s could trigger broader contagion in this part of the bond market.

Syz Bank’s Monchau says: “This is an arresting development, given that even unsecured bondholders usually rank above equity holders in the capital structure.

“So for equity holders to get ‘something’ and CoCo bond holders to get ‘nothing’ raises serious questions about the real value of CoCo bonds. This is creating contagion risks on CoCos. There is also a risk of spillover effect on global credit.”