US distressed debt investors and corporate litigators are preparing to fight the Swiss government over its decision to write down $17bn of Credit Suisse bonds as part of the bank’s shotgun marriage with UBS.
Switzerland provoked the ire of bond investors when the government used an emergency ordnance to write down the bonds to zero, even as it orchestrated a deal where UBS will pay $3.25bn to shareholders.
AT1s are a class of debt designed to take losses when institutions run into trouble but are generally believed to rank ahead of equity on the balance sheet.
“If this is left to stand, how can you trust any debt security issued in Switzerland, or for that matter wider Europe, if governments can just change laws after the fact,” David Tepper, the billionaire founder of Appaloosa Management, told the Financial Times. “Contracts are made to be honoured.”
Tepper is among the most successful investors in troubled financial companies, famously making billions of dollars on a 2009 wager that US banks would not be nationalised during the last financial crisis. Appaloosa had bought a range of Credit Suisse’s senior and junior debt as the bank descended into chaos.
Mark Dowding, chief investment officer at RBC BlueBay, which held Credit Suisse AT1 bonds, said Switzerland was “looking more like a banana republic”. His Financial Capital Bond fund is down 10.7 per cent this month.
Some funds have been buying exposure to the debt in preparation for the legal battle. Goldman Sachs is one of the banks facilitating claims trading and has offered prices at single-digit cents on the dollar.
Quinn Emanuel Urquhart & Sullivan and Pallas Partners are among the law firms representing bondholders, with Quinn hosting a call on Wednesday joined by over 750 participants.
Quinn partner Richard East told the Financial Times the deal was “a resolution dressed up as a merger” and pointed to statements by the European Central Bank and the Bank of England, which distanced themselves from the Swiss approach.
“You know something has gone wrong when other regulators come and politely point out that in a resolution [they] would have respected ordinary priorities,” he added.
Quinn is eyeing lawsuits in multiple countries, according to lawyers at the firm. Potential avenues include challenges to the actions of the regulator Finma on the basis of a violation of investors’ property rights or an arbitrary exercise of discretion.
The firm is also probing whether Credit Suisse could be liable for mis-selling over statements made to investors, including in an investor presentation in March.
Pallas Partners also held a call with potential clients on Wednesday afternoon. Natasha Harrison, the firm’s founding partner, said there was “a very good argument that misrepresentations and misstatements have been made about the financial safety of Credit Suisse as recently as 14 March”.
Credit Suisse’s AT1 bonds started to plunge last week after its largest investor ruled out providing more capital and wealthy clients withdrew SFr35bn in deposits.
Global distressed funds saw an opportunity and bought some of the riskiest debt, gambling that the government would not let its second-largest lender collapse and would instead arrange a merger with its rival, UBS.
While the terms of Credit Suisse’s AT1 bonds warned that Swiss regulators “may not be required to follow any order of priority” — several investors and analysts have argued that the contractual conditions for writing down the bonds were not met.
Usually, AT1s can only be triggered if a “viability event” occurs, described in the prospectus as when “customary measures” to improve the bank’s capital adequacy are “inadequate or unfeasible” or the institution receives “an irrevocable commitment of extraordinary support from the public sector” to prop up its capital level.
The Swiss government said last week that a law change had given it a “clearer legal basis” to wipe out the bonds.
Pimco, Invesco, BlueBay and Legg Mason are among the longer-term holders of Credit Suisse’s AT1 bonds.
Värde Partners, a prominent alternative credit investor founded in Minnesota, had a small position in AT1 bonds going into the fateful weekend, according to a person familiar with matter.
Funds run by Algebris Investments, Lazard and GAM are among fund managers that have been hit hard by a wider sell-off in AT1 debt.
AT1s fell as much as 19.5 per cent in the month to the end of Monday, according to an iBoxx index of such debt, although they have since recovered some ground.
Lazard Capital Fi fund, which invests in AT1s including Credit Suisse, lost 9 per cent on Monday, taking losses this month to 17.3 per cent.
Additional reporting by Sam Jones in Zurich