By Tom Westbrook and Xie Yu
SINGAPORE/HONG KONG (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.
That puts holders of the AT1 bonds lower in priority than even investors who hold an equity stake in Credit Suisse and can expect to get 0.76 Swiss francs per share.
The shock realisation reverberated through Asian markets on Monday as traders hurried to reprice bank debt, and pushed bank stocks down.
Banks stocks fell. MSCI’s world bank stock index was at 84, down from 100 in two weeks.
HSBC Holding’s 8% U.S. dollar perpetual bond issued on March 7 was being traded 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.
Deutsche Bank’s 7.5% perpetual or AT1 bond had already fallen to 81 cents from above 98 in the past 5 weeks.
“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, the AT1 prospectus made clear it wouldn’t, and that when there was a write-down event, “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 analysts said in a note.
Credit spreads on banks should widen further, analysts said. Swap spreads on U.S. banks, indicated by the ICE BofA index , has already moved to 198 basis points from 128 early in 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.”
(Additional reporting by Lewis Jackson in Sydney, Summer Zhen in Hong Kong, Ankur Banerjee and Anshuman Daga in Singapore; Writing by Vidya Ranganathan; Editing by Simon Cameron-Moore)
