Dhe UBS takeover of Credit Suisse, backed by the Swiss government, is causing a stir in the subordinated bank bond market. Because investors in this bond class, which was only introduced after the great financial crisis, have to bear losses of 16 billion francs, although the shareholders of the ailing major bank still receive around 3 billion francs in the form of UBS shares.
That’s not the pecking order that investors in these mandatory convertibles relied on until recently. Accordingly, the shareholders, i.e. the equity, would have to bear the losses first. Only then would the subordinated bonds be used, which bear higher interest due to the greater default risk compared to normal (senior) bonds.
However, the fact that Switzerland has chosen a different path here is causing uncertainty in the $275 billion market. Once again, the devil is in the details. These subordinated bank bonds are called AT1 bonds in the market. The abbreviation stands for “Additional Tier 1”, which can be translated as additional Tier 1 subordinated capital. These AT1 bonds, which are sometimes also called “Coco” bonds (“Coco” stands for Contingent Convertible Bonds), serve as an additional loss buffer for the banks after the common equity consisting of shares and retained earnings.
In the event of certain events, usually falling below the equity ratio, these securities can either be converted into shares or written off. On the other hand, this asset class has attractive returns, as fund managers were advertising just weeks ago. An AT1 bond issued by French BNP Paribas this year carries an interest coupon of 7.375 percent. Deutsche Bank is paying interest on its AT1 bond issued in November 2022 at 10.0 percent.
But now investors have realized that higher interest rates mean a higher risk of default. The European Central Bank (ECB), the European resolution fund SRP and the EU banking regulator EBA pointed out on Monday that in a European bank rescue or resolution, the shareholders would first have to bear the losses and only then the AT1 creditors. In other words: Claiming the subordinated bonds as in the case of Credit Suisse would not be possible.
Goldman Sachs to prepare offer
There are different opinions as to whether it is possible in Switzerland. According to a report by the Bloomberg news agency, the American investment bank Goldman Sachs is preparing an offer for Credit Suisse AT1 creditors. Goldman Sachs would then acquire the stocks at a discount in the hopes of getting a better price after legal action or a settlement with the authorities.
Triggers shock waves on the bond market: the President of the Swiss Financial Supervisory Authority FINMA, Marlene Amstadt
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American investor Jeffrey Gundlach, at least, has his doubts as to whether the calculation will work out. The founder of the investment company Doubleline Capital has blamed investors via the short message service Twitter for having invested too carelessly in these risky Credit Suisse securities. Apparently, claiming the AT1 bonds for losses is still allowed under Swiss law before the shares. The Swiss Financial Market Supervisory Authority (FINMA) justified the decision with the “extraordinary government support” that triggered a complete write-down of the nominal value of all AT1 bonds from Credit Suisse and thus an increase in core capital.
Financing can become more expensive for banks
But the still comparatively young market is now completely insecure. The AT1 titles were under pressure on Monday. They each lost more than 10 percentage points. The specialized fund Invesco AT1 Capital Bond lost 9 percent. The fact that titles are more important than shares in one country, but not in another, creates distrust. The write-down at Credit Suisse means a reassessment of the risks for investors, wrote the analysts at Bayern LB.
“Financing via AT1 bonds will become significantly more expensive for banks because investors have to be compensated for the higher risks,” said Jochen Felsenheimer, managing director of Munich-based asset manager Xaia Investment, in an interview with the FAZ. In his opinion, this bond class is urgently needed a restructuring. Documentation and legal conditions would have to become much more transparent.
At least Deutsche Bank, DWS, Commerzbank and Union Investment are hardly affected by the write-downs at Credit Suisse. They hardly if ever hold those AT1 titles.