Analysis-Credit Suisse rescue presents ‘buyer beware’ moment for bank bondholders

By Tom Westbrook

SINGAPORE (Reuters) – The rudest shock in the rushed deal to save embattled Swiss lender Credit Suisse Group AG was reserved for the holders of the bank’s riskiest tranche of bonds.

Not only did they discover they are the only investors not getting any compensation but that the long-established practice of giving bondholders priority over shareholders in debt recovery had been turned on its head.

Banks had already been paying far more this year than in the past for such hybrid capital, and now there would be no takers, analysts said. 

Swiss authorities brokering Credit Suisse’s rescue merger with UBS have said 16 billion Swiss francs ($17 billion) of its Additional Tier 1 (AT1) debt will be written down to zero.

AT1 bond holders rank below those holding equity stakes in Credit Suisse who can expect to receive 0.76 Swiss francs per share.

That shock rippled through Asian markets on Monday, causing bank credit default swaps to widen and stocks to fall. MSCI’s world bank stock index stood at 84, down from 100 in two weeks. European bank shares and bonds slid as traders re-priced the risk and cost of banks’ capital .

“With the restructuring of Credit Suisse, no-one had really thought about how it would affect the AT1 and that was a fat tail risk,” said Sean Darby, global equities strategist at Jefferies in Hong Kong.

The issue lay not in the structure of such debt but how markets were unprepared for this outcome in a debt structuring, he said.

“What the market is saying today, is that between now and maturity there’s a risk on this debt which hadn’t been priced correctly in light of what’s happening in banks in the U.S. and around the world.”

HSBC Holding’s 8% U.S. dollar perpetual bond issued on March 7 was trading at 90 cents to the dollar, a wealth manager said.

Asian AT1 bonds were down 4-5 points, while European ones were down 10 points, he said.

A $1 billion Credit Suisse AT1 bond with a coupon of 4.5% was bid as low as 1 cent on the dollar, Tradeweb pricing showed. A London-listed exchange-traded fund that tracks banks’ AT1 debt tumbled 15.7%.

“When an investor buys an AT1 he knows he’s down the capital structure compared to senior. But he assumes he’s above equity,” Steven Major, global head of fixed income research at HSBC, said on the phone from Melbourne.

“People have been scrambling through the weekend to think all of this out. It’ll be difficult for new issues to get down when you have a big widening out of spreads, with AT1s leading the way.”

Created in the wake of the global financial crisis, AT1 bonds are a form of junior or hybrid debt that counts towards banks’ regulatory capital.

They were designed as a part of total loss-absorbing capacity (TLAC) bonds to provide a ‘bail-in’ or a way for banks to transfer risks to investors and away from taxpayers if they got into trouble.

The AT1 bonds, which also carry a higher coupon, can be converted into equity or written down when a lender’s capital buffers are eroded beyond a certain threshold.

AT1 write-downs have taken place in several countries, including Spain, Greece, Austria and Denmark.

EUROPE IS DIFFERENT

John Likos, director at BondAdviser, a debt research house and asset manager, said Australian AT1s contain provisions that would make it very difficult for local regulators to engineer a Credit Suisse type situation where hybrids went to zero while equity holders recovered some value. 

“Bizarre, strange parallel universe that equity gets something and hybrids don’t,” Likos said.

In the case of Credit Suisse, however, the AT1 prospectus made clear that hybrid (AT1) holders would not recover any value.

It said in the event of a write-down “interest on the Notes shall cease to accrue, the full principal amount of each Note will automatically and permanently be written-down to zero, Holders will lose their entire investment in the Notes…”.

“We think this is quite negative for AT1 and broader TLAC securities worldwide as it highlighted the inherent risks present in these instruments,” Deutsche Bank (ETR:) analysts said in a note.

U.S. bank Goldman Sachs Group Inc (NYSE:) traders were preparing to take bids on claims against Credit Suisse AT1 bonds, Bloomberg News reported on Sunday, citing people familiar with the matter.

Graphic: Banking system stresses heightened

Credit spreads on banks should widen further, analysts said. Swap spreads on U.S. banks, indicated by the ICE (NYSE:) BofA index , have already moved to 198 basis points from 128 in early March. For BBB-rated European banks, the spread is up 50 bps in a month to 174.

“If you take 10% yield on something when the government security is 4%, then you’re earning a lot of extra yield for a reason. But you did enter this thing believing that you’d be senior to the equity holders, that’s the thing that people are worried about.”