The hastily arranged purchase of Credit Suisse, a bank, by ubs, its great rival, is reverberating through financial markets. Investors are scrambling to understand the deal and identify knock-on consequences. One is already clear. The decision to write down around SFr16bn ($17bn) in Additional-Tier 1 (at1) bonds issued by Credit Suisse—while stockholders merely suffered enormous losses—is causing fury and pain elsewhere. Some observers fear it could even spell the end of the asset class.
at1 securities are a form of “contingent-convertible” (coco) bonds, part of the toolkit created after the global financial crisis of 2007-09 to prevent future bail-outs. In good times, they act like relatively high-yield bonds. When things go sour and trigger points are reached—such as a bank’s capital falling below certain levels relative to assets—the bonds convert to equity or are written down, cutting the bank’s debt and absorbing losses. In a post-collapse pecking order, at1 bondholders should come between senior bondholders, who have a right to payouts first, and stockholders, who in theory take first losses.
Credit Suisse has shaken the market for at1 bonds, now worth around $275bn, for two reasons. One is the size of the write-down, the biggest in the history of cocos by some way. The other is the fact that stockholders emerged above at1 bondholders in the pecking order. When Banco Popular, a mid-sized Spanish lender, failed in 2017, it took about $1.4bn of at1 bonds with it—less than 10% of Credit Suisse’s write-down. Crucially, Banco Popular’s shareholders were also wiped out. The bank was sold to Santander, a local rival, for the nominal price of €1 ($1.11).
Credit Suisse’s debt-issuance documents seem to allow for stockholders coming out on top. They note that at1 bond buyers have waived any right to reimbursement in a “write-down event”. Yet the idea that stockholders may be left with something and coco holders with nothing is contrary to the understanding many buyers had about what they were purchasing: namely, a hybrid security somewhere between stocks and debt in the stack of capital. This is reflected in the sell-off in some forms of bank debt on March 20th. The weighted-average price of Deutsche Bank’s at1 bonds, for instance, fell by nearly 9.5%.
Regular buyers of cocos may be the first to wobble. As recently as January, the investment committee of Union Bancaire Privée, a Swiss private bank, argued that the high yield on cocos made them an attractive investment in the context of strong balance-sheets at European banks. Private banks in Asia have historically been keen buyers, snapping up issuances for their ultra-wealthy clients.
Commentary about the future of the asset class ranges from bleak to apocalyptic. Goldman Sachs has warned that it has now become difficult to assess the attractive-looking spread between yields on at1 bonds and different forms of high-yield credit, owing to a lack of clarity about how future resolutions would work. Others have taken a more extreme view. “Credit Suisse may not be the only thing that died today,” said Louis-Vincent Gave, co-founder of Gavekal, a research firm. “The terms of the Credit Suisse take-under is likely to kill the coco market.”
Cocos have faced criticism before and survived. In 2016 the market kept going despite a near-death experience for at1 bonds issued by Deutsche Bank, when it was unclear if the German lender would be able to make interest payments. In 2020, during the collapse of Yes Bank, an Indian lender, at1 investors were zeroed while stockholders were allowed to limp on. This time round, on March 20th euro-zone regulators were quick to put out a statement saying that under their watch at1 bonds would be written down only after common-equity instruments absorbed losses, which should boost the bonds’ survival chances.
Yet after the example of Credit Suisse investors have reason to doubt such fine words. And if regular coco buyers feel they have been burned, they will be far less likely to return to the market. At a time when banks are already facing pressure, the last thing they need is fewer willing investors. ■