Holders of $17bn of Credit Suisse bonds will have their investment wiped out following the bank’s takeover by UBS, in a surprise move that is expected to cause ructions in European debt markets when they open on Monday.
As part of the historic deal between the banks, Swiss financial regulator Finma ordered that SFr16bn of Credit Suisse’s additional tier one (AT1) bonds, a relatively risky class of bank debt, will be written down to zero.
Credit Suisse said it was informed of the decision by the regulator as it thrashed out the final details of its SFr3bn takeover by UBS, which was announced on Sunday evening after several days of intense negotiations.
“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, and thus an increase in core capital,” Finma said.
But several people involved in negotiating the deal said wiping out AT1 holders — a move that appeared to surprise markets — would have wider repercussions and was likely to lead to a sell-off of other bank debt.
Traders quoting prices on Credit Suisse’s AT1 bonds on Sunday afternoon had marked them up significantly after the Financial Times reported that UBS’s takeover was confirmed, in expectation that the deal would not result in losses for bondholders.
“What Finma has done breaking capital structure will have a long-term consequence for any Swiss financial debt,” said one Credit Suisse AT1 holder.
One banker said the decision could lead to a “nightmare” in European debt markets, particularly given bondholders were having heavier losses forced on them than shareholders in Credit Suisse.
While AT1s are typically owned by professional bond investors and hedge funds, they are also popular among retail and wealth management investors in Asia.
“The market is likely to be shocked by such a blatant inversion of the hierarchy of creditors and by the decision to sweeten an equity deal at the expense of bondholders,” said Jérôme Legras, head of research at Axiom Alternative Investments.
AT1s were introduced as part of the post-global financial crisis regulatory reforms that pushed banks to increase their capital levels. AT1s are a form of contingent convertible security, or coco, which can be converted into equity if the bank runs into trouble.
If a bank’s capital ratio falls below a predefined threshold, AT1 investors can lose their principal or have their investment converted to equity.
As the riskiest form of bank debt in Europe, AT1s typically offer higher yields than safer bonds.
The Credit Suisse deal echoes the takeover of stricken Spanish lender Banco Popular in 2017, where the bank’s AT1 bonds were wiped out in the first example of the value of the hybrid asset class collapsing in the rescue of a European bank.
The takeover by Santander had been orchestrated by the European Central Bank’s oversight unit, the Single Resolution Body, after the ECB deemed the bank was “failing or likely to fail”.