The Swiss authorities' handling of the Credit Suisse rescue has upended the markets' expectation that shareholders would take a bigger hit than bond investors in such a scenario.
Under the Credit Suisse rescue deal, 16 billion Swiss francs worth of Credit Suisse Additional Tier 1 debt will be written down to zero on the orders of the Swiss regulator. So such bonds, known as AT1s or "CoCos" (contingent convertibles, were at the centre of the sell-off in Europe. These bonds can convert into equity or be written off if a bank’s capital levels fall below a certain threshold, depending on the terms of each individual instrument. The write-down to zero at Credit Suisse will produce the largest loss in the $275 billion AT1 market to date, dwarfing the 1.35 billion euros ($1.44 billion) bondholders of Spain's Banco Popular lost in 2017.
Bid prices on AT1 bonds from banks, including Deutsche Bank , HSBC , UBS and BNP Paribas , were among those under pressure on Monday. They recovered marginally but were still down 6-11 points on the day, sending yields sharply higher, data from Tradeweb showed.
A UBS AT1 bond callable in January 2024 was trading at a yield of 27%, up from 12% on Friday, demonstrating how much more costly this type of debt could become in the wake of the Credit Suisse rescue.
"AT1s suffer from a major crisis of confidence now," said Marco Pabst, group chief investment officer at Arbion. "They are hard to value in the best of days and have just become an even more problematic asset class today. Investors who want a similar risk profile could just buy the stock and a more senior bond," Pabst said. BANK SHARES TURN POSITIVE
European bank stocks fell as much as 6% in early trading on Monday, hitting their lowest level since November, but then turned positive. Analysts attributed the recovery partly to dip-buying and short-covering, but also to a statement by European supervisors which said owners of AT1 debt would only suffer losses after shareholders had been wiped out, unlike at Credit Suisse.
"The bounce in bank stocks today is also more of a short-term relief rally that the CS affair is now finished but I doubt this will last long," Pabst said. "With the rate hike cycle likely over, the prospects for banks just deteriorated significantly," he said, referring to expectations that central banks are nearing the end of their moves to raise interest rates.
Overall, bank debt remained under pressure, with the cost of insuring exposure to the debt rising in the credit default swaps (CDS) market.
UBS CDS widened 63 basis points to 180 bps - levels last seen more than a decade ago. Among the other banks, Deutsche Bank and UniCredit saw some of the sharpest increases at 20 bps and 13 bps respectively, S&P Global Market Intelligence data showed. CONTAGION RISK The wipeout of AT1 bonds in the Credit Suisse rescue has alerted fixed income investors to the risks of investing in these instruments.
"The specific CS situation is mostly bedded down now, but it’s no time for complacency," said Wolfgang Felix, senior analyst at credit firm Sarria Limited. "Investors realise that these bonds contractually circumvent the concept of absolute priority to their own disadvantage."
"So the mob is angry and scared and is looking for the next best target. The focus is moving to other issuers of CoCos, which includes most of Europe’s larger banks. It’s not a good situation." Funds that track AT1 debt also fell sharply.
Invesco's AT1 Capital Bond exchange-traded fund was last down 6%, having been over 10% lower earlier. WisdomTree's AT1 CoCo bond ETF was indicated 9% lower. At Credit Suisse, the bank's AT1 bonds were bid as low as 1 cent on the dollar on Monday as investors braced for the wipeout. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ BREAKINGBVIEWS-Switzerland takes CoCos to the point of non-viability EXPLAINER-Why markets are in uproar over a risky bank bond known as AT1 ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Reporting by Yoruk Bahceli, Lucy Raitano, Chiara Elisei, Amanda Cooper, Danilo Masoni; Editing by Amanda Cooper and Jane Merriman)
