The recent bank run has claimed several scalps in the banking world and the biggest one was Credit Suisse (CS). After 166 years of operation, this prestigious name is no more. Its dramatic collapse happened within days after the SNB (Swiss National Bank) central bank forced UBS to take over CS at a fraction of the last traded share price plus including a lot of free backstops to the buyer.
UBS was the unwilling suitor that was dragged into the altar kicking and screaming in horror at the forced shotgun marriage to save its main competitor. The number one Swiss bank will now absorb the number two to form the biggest bank in the whole of Switzerland. Yes, the Swiss banking system is officially a monopoly now.
CS shareholders watch in despair that their beloved bank was sold for about CHF 76 cents from the last traded price of over CHF 2 dollars. UBS will convert CS shareholders to CHF 3 billion worth of UBS shares as a purchase price agreement. At its peak in 2007, CS was worth CHF 75 and now sold at CHF 0.76, a 99% drop.
The other bigger shocker was that the outstanding CHF 17 Billion of Additional Tier 1 (AT1) of Coco (Contingent Convertible) bonds were written down to zero value overnight. This was the first time that it had happened to the AT1 Coco bond industry which currently has a total value of USD 275 Billion in outstanding bonds globally.
AT1 Cocos bonds are bank capital securities that banks issue to contribute to the total capital required by regulators. Higher capital adequacy norms were imposed after the 2008 global financial crisis when several high-profile banks collapsed. AT1 was therefore created and issued by banks for additional capital to help absorb losses in an event of a collapse. This mitigates the need for a bailout from the regulators and instead requires AT1 bondholders to be the next in line to absorb the losses after all the shareholders are wiped out.
AT1 bonds are usually issued as perpetual bonds and are junior subordinated. They are classified as hybrid securities as they have features similar to bonds and equity (Convertible). The bonds do not have a maturity date and it is at the sole discretion of the bank to call back the bonds on their call date. AT1 bonds are therefore riskier than typical plain-vanilla bonds due to the subordination of the bond.
The credit ratings for AT1 bonds are also rated a few notches below the respective bank’s issuer ratings. This is due to the higher risk of investing in these bonds due to the respective clauses and its ‘hybrid’ nature between equity and bonds. Due to its higher risks, AT1 bonds are issued at a higher coupon in order to compensate investors for taking on more risk.
These AT1 bonds may result in a total write-off and become zero value for the investors when a trigger event happens. A trigger event, as defined in the document clauses, may be caused by a 1) contingency event OR a 2) viability event. When either of these events occurs, a partial or full write-off of AT1 bonds will be automatically triggered.
1) A contingency event may be triggered when a bank’s capital adequacy ratio falls below a certain threshold. Typically, the threshold level where AT1 bonds are to be written off is when Common Equity Tier 1 (“CET1”) ratio falls below either 5.125% or 7.00% depending on the terms of the AT1.
2) Meanwhile, a viability event is triggered when regulators deem that a write-down is necessary in order to prevent the bank from becoming insolvent or bankrupt. A viability event can be triggered if measures to improve a bank’s capital adequacy are deemed inadequate by regulators to prevent insolvency or bankruptcy or when a bank receives support from the public sector to boost its capital adequacy.
When the UBS takeover of CS was being finalized, FINMA (Switzerland’s independent financial markets regulator) determined that a viability event had been triggered and hence CS’s AT1 clause was breached. The bonds were immediately written down to zero value.
The bondholders screamed murder because the assumption was that shareholders were supposed to be wiped out first before the AT1 bonds. Yet shareholders managed to get CHF 3 Billion of UBS shares from the buyer while the AT1 bondholders got nothing. The move shocked the whole AT1 industry as it had never happened before.
Of the total CHF 17 Billion outstanding CS AT1 bonds, most were denominated in USD except one. The exception was in SGD and supposedly had a size of about SGD 1 Billion. It looks like the SGD 1 billion tranches were mainly owned by Asian HNWI (High Net Worth Individuals) clients based in Singapore. I suspect that the CS Wealth management arm and most private banks may have marketed them to their clients as a relatively great investment with attractive yields.
This CS 5.625% Perpetual Corp (SGD) that was issued in 2019 probably had a yield of almost 9.75% in SGD in late 2022 as it had traded below par by then. Most investors would have assumed last year that it was unlikely that a global name like CS could go under that easily. Given that the minimum size for execution is SGD 200,000, it would have attracted a lot of private bank customers who are always on the lookout for higher yields. With a global banking name like CS paying almost 10% on a bond pre-2022 aggressive rate hikes, why not?
Imagine waking up the next day a few days ago to be told that your bond is now worthless, without the opportunity to be converted to equity while the shareholders were not wiped out first. Lawsuits should be flying fast and furious now. A lawyer friend of mine just mentioned that he has been experiencing all-nighters in the office for the last few days. This topic is probably top of mind for many HNWI customers looking to lawyer up.
I honestly don’t think that the bondholders stand a good chance of winning this debate as the SNB had already blessed the FINMA decision to completely write down this bond. It could be a long drawn out lawsuit that could take years of court battles to fight. Even if they win, the best case is that they will get CHF 3 Billion from the shareholders. This will be less than 20% of the bond principal notional (17 outstanding / 3 from UBS). The lawyer fees will also add up and eat into the recovered sum. They might have to give up and move on at some point in time.
Regulators have learnt an important lesson from the 2008 GFC. Bank shocks require quick preventive actions to proactively avoid contagion which could make the situation even worse in the end. The domino effect made the GFC even bigger as one after another bank was swallowed into the black hole. Regulators were headless chickens then and spent too much time debating on what to do next.
I for one do not think that we are in a worse situation now than in 2008. The leverage is much less and there is less toxic stuff now. Remember GFC’s CDO squared derivatives with exponential risk? Regulators are also reacting much earlier to stem the rising panic tide. There are rumbles and rumours of DB being the next victim as we head into the weekend… Let’s see what other surprises may hold for us next week.
Meanwhile, a number of opportunistic fund managers are buying other AT1 bonds due to the crazy market price dislocation as they see upside value. Another group is also grabbing AT2 (Tier 2) as they see an oversold situation as a safer alternative, to purchasing cheap and oversold bonds.
Leave a Reply