Credit Suisse bondholders were in uproar on Monday and the European Central Bank raised concerns after the rescue deal by rival UBS wiped out $17bn of the failed Swiss bank’s bonds, upending debt recovery norms and undermining financial market confidence.
“In my eyes, this is against the law,” said Patrik Kauffman, a fund manager at Aquila Asset Management, who invests in additional tier 1 (AT1) bank debt.
He said it was “insane” that under the terms of UBS’s takeover of Credit Suisse, AT1 bondholders were set to receive nothing while shareholders would walk away with SFr3bn ($3.2bn). “We’ve never seen this before. I don’t think this would be allowed to happen again.”
Davide Serra, founder and chief executive of Algebris Investments, said the move was a “policy mistake” by the Swiss authorities. “They changed the law and they have basically stolen $16bn of bonds”, he said in a widely attended call on Monday morning.
AT1s have grown into a roughly $260bn market since they were introduced in the aftermath of the global financial crisis, as part of regulatory reforms that required banks to increase their capital levels.
The so-called contingent convertible securities, which are designed to absorb losses, are a relatively risky form of bank debt. They can be converted into equity if a bank’s capital ratio falls below a certain level, or investors can lose their principal entirely.
The Swiss authorities’ decision to leave AT1 bondholders with nothing has turned upside down the long-established norms of debt investors being prioritised over equity holders in a debt recovery.
Jérôme Legras, head of research at Axiom Alternative Investments, which holds Credit Suisse AT1s, also said that wiping out the AT1 holders was a policy mistake by Finma, the Swiss regulator.
“Everyone knows that when you’re buying AT1 bonds you’re taking risks and you’re there to absorb losses. But show me the losses — there’s still SFr45bn of equity in the bank,” he said.
“Shareholders got SFr3bn and AT1 holders got nothing, which is a reversal of the usual hierarchy.”
Investors’ complaints came despite the fact that Credit Suisse’s bond documentation made it clear that Swiss regulators could alter the traditional order in which creditors or shareholders were repaid. Finma “may not be required to follow any order of priority, which means [AT1 bonds] could be cancelled in whole or in part prior to the cancellation of any or all of [Credit Suisse’s] equity capital”, the prospectus said.
Even so, other investors said reversing the market norms could herald a significant reduction in appetite for AT1s.
“This could be the end of that market for the foreseeable future,” said Jim Leaviss, chief investment officer of public fixed income at M&G. “Global investors won’t be interested for a while or at least until the yields adjust significantly higher, but at that point, the yields will likely be too high for banks to want to issue them as a cheaper source of funding than equities.”
The ECB questioned the Swiss authorities’ move on Monday, saying equity instruments “are the first ones to absorb losses” and only after that would AT1s need to be written down. “This approach has been consistently applied in past cases,” the ECB said, adding that AT1 debt remained “an important component of the capital structure of European banks”.
The Bank of England later said a “clear statutory order” existed for bank resolutions, namely that AT1 holders would be exposed to losses after equity investors.
As the riskiest form of bank debt in Europe, AT1s typically offer higher yields than safer bonds, and are popular among professional bond investors and hedge funds, as well as retail and wealth management investors in Asia.
On Friday, Goldman Sachs said the weakening in this type of debt in the previous few days represented a buying opportunity — a sign that professional analysts still saw it as a robust asset class as recently as last week. But the structure of the Credit Suisse takeover blew out that view. The “decision to write down AT1 bonds while preserving some shareholder value greatly weakens the case to add risk”, Goldman said on Sunday.
Prices of risky bank debt in Europe tumbled on Monday morning as markets digested the decision.
AT1s issued by other European banks were down by roughly 10 points in early trade, according to Tradeweb data. UBS bonds traded at 83 cents on the dollar, and Deutsche Bank AT1s were at roughly 63 cents on the dollar. BNP Paribas AT1s were trading at 70 cents on the dollar.
An Invesco exchange traded fund tracking AT1s plunged 11 per cent on Monday morning.
Legras said the move could undermine trust in financial markets. “It’s more than a pure legal issue — it’s about market confidence and how you treat investors fairly . . . here you have the Credit Suisse exception but also the Swiss exception,” he said.
He added that Finma was more flexible than other regulators. “It would be difficult to implement in the EU or the UK.”