Investors rethink risk after Credit Suisse bonds wiped out

Last month, UBS agreed to buy rival Credit Suisse for CHF3 billion. The state-backed rescue also involved the financial regulator Finma wiping out $17 billion worth of the ailing bank’s AT1 debt, as part of the emergency acquisition deal. © Keystone / Michael Buholzer

Investors are questioning the future of the $260 billion market for additional tier 1 bank debt, following a decision by Swiss regulators to write down Credit Suisse’s AT1 bonds in its rescue takeover by UBS.

Last month, Swiss financial regulator Finma angered Credit Suisse bondholders by wiping out $17 billion worth of the ailing bank’s AT1 debt, as part of the emergency UBS acquisition deal.

AT1 bonds are a class of debt introduced after the global financial crisis and designed to take losses when institutions run into trouble — but they are generally deemed to rank ahead of equity on a bank’s balance sheet. In the Credit Suisse rescue, however, the value of its AT1s was written down from $17 billion to zero, while equity holders were allowed to receive $3.25 billion.

That left the bondholders with nothing, and ranking behind shareholders — which has led some to doubt the future of the AT1 debt market and the mechanism for absorbing losses.

Lawyers at Swiss law firm Jacquemoud Stanislas recently questioned the “proportionality of the Finma decision” and argued that “less invasive measures for holders of AT1 bonds could have been implemented”.

Finma’s actions led to a sharp sell-off in AT1 bonds globally and, although prices have since rebounded, investors and analysts remain concerned about the ramifications of the write down for the rest of the AT1 market. Swiss debt is a particular point of concern, given the national regulator’s impromptu decision to override conventions and leave Credit Suisse AT1 holders completely wiped out.

“This comes to . . . can you trust the system in Switzerland now?” says Mark Holman, chief executive of investment firm TwentyFour Asset Management. “Some people will be saying ‘I’m not going to buy Swiss risk because I don’t trust the regulatory backdrop’.”

JPMorgan analysts have suggested that investors consider a Swiss “legal risk premium”, noting that a collapse in confidence “should be relatively contained to the Swiss AT1 market, given the proven propensity for the local regulator to undermine bondholder interests and override contractual terms with ad hoc legislation.”

Confidence in Swiss AT1 bonds certainly remains low and investors still deem them relatively unappealing. A Swiss franc-denominated UBS AT1 bond has recovered only 3 per cent in price from its recent low.

Elsewhere, however, officials have been quick to say that they would not follow Switzerland’s example if a similar situation were to occur — and would instead wipe out shareholders first. Statements to this effect from the European Central Bank and Bank of England, among others, have reassured some investors and analysts that Finma’s decision was an anomaly, and would not set a precedent for AT1s globally.

Michelle Brennan, credit analyst at S&P Global Ratings, says investors now understand that other countries “may not automatically follow the Swiss pattern”. But she stresses that AT1 investors “have been reminded of their extreme vulnerability if a bank gets into trouble, and of their dependency on decisions taken by regulators and governments.”

AT1 bonds were originally born out of a regulatory desire for banks to shift risk away from their depositors and on to their bondholders, and to meet higher capital requirements, thereby reducing the chances of failure.

They are also sometimes referred to as contingent convertibles, or Cocos, because, as well as being written down, the bonds can be converted into equity if a bank’s capital ratio falls below a certain level.

In return for taking on these risks, banks typically reward AT1 bondholders with a higher rate of interest. And, following the Credit Suisse rescue, they are likely to have to pay more on new bond issuances. According to Brennan of S&P, “investors will demand notably higher coupon rates for new AT1 instruments” in the coming months, which may lead banks to seek cheaper funding elsewhere such as through “common equity raising . . . or else curtail balance sheet expansion”.

So far, though, they have put these decisions off. Earlier this month, Japan’s Mitsubishi UFJ Financial Group delayed issuing new AT1 bonds planned for April until at least mid-May. Since the turmoil surrounding the takeover of Credit Suisse, no large global banks have issued any new AT1 debt.

Meanwhile, prices of existing bonds remain well below the levels seen at the start of the year.

An iBoxx index of AT1 prices is only back to where it was in March, before the Credit Suisse takeover. Similarly, an Invesco exchange-traded fund of AT1 debt has recovered only as far as its pre-acquisition price.

Global regulators are still reviewing lessons from across the banking sector. Klaas Knot, chair of the Financial Stability Board, wrote to G20 ministers and central bank governors last week, acknowledging that the Swiss banking turmoil, as well as the bankruptcy of Silicon Valley Bank in the US, had tested financial resilience.

He said the FSB would “carefully analyse recent events in order to learn from them” and that its members “stand ready to take policy measures to maintain the resilience of the global financial system”.

Copyright The Financial Times Limited 2023