By Marcus Ashworth
(Bloomberg Opinion) — UBS Group AG, having subsumed Swiss
Bank Corp. 25 years ago, is now absorbing Credit Suisse Group
AG, creating a single Swiss banking giant. The Credit Suisse
shareholders get something, the senior bondholders are protected
— but that luxury does not extend down the capital stack. How
banks are able to finance themselves is poised to become a lot
more challenging.
To facilitate the deal and join up the numbers, the Swiss
regulator Finma has ordered that about 16 billion Swiss francs
($17.3 billion) of Credit Suisse’s riskiest type of debt will
now be worthless. Known as Additional Tier 1 bonds, and also
called contingent convertibles or CoCos, this debt can be
converted into equity or written off if a bank’s capital falls
below a prescribed level. Owners of the Swiss firm’s securities
will get nothing. It was a lovely asset class while it lasted.
Weaker European banks will struggle even harder to find
investors to commit capital that, not just in theory but in
practice, really can be wiped out. The entire banking sector
will end up paying for Credit Suisse’s myriad transgressions one
way or another. The repercussions of the Swiss takeover
structure may close off access to CoCos for all but the
strongest banks — the definition of which will come under ever-
closer scrutiny.
The ramifications could cause a world of pain for banking
regulators. It is not a coincidence that over the weekend global
central banks have agreed a coordinated increase in dollar swap
funding lines to keep liquidity greasing the wheels of the
financial system.
AT1s are meant only for sophisticated investors who truly
understand the risks. However, even professionals face a rude
awakening this week — and this specific zeroing of one asset
class for the benefit of all others will send a seismic shock
through the entire $275 billion European bank subordinated debt
market. This asset class is the building block that underpins
the inverted triangle of all financial institutions’ equity
capital base. Who’s going to insure basement flooding after this
storm?
That highly subordinated bank capital can be bailed-in when
a bank fails is a known known. US investors tend not to have any
illusions about how risky this type of debt is, but the
potential for a total loss was underappreciated in Europe. Many
investors secretly felt it was one of those risks in life worth
taking to clip a big fat coupon, as yields are so much higher
than on the senior preferred or covered bank-debt categories. By
only investing in highly-regarded banks — like perhaps a storied
167-year old Swiss institution with a local duopoly— then
hopefully the risks were minimal. It’s worked a treat for the
best part of 15 years.
The brutal reality is it’s yet another cockroach crawling
out from the fixed-income world as a consequence of central
bankers aggressively hiking from below-zero interest rates.
Investing in AT1s made a lot of sense for big fund managers
tracking an index. The higher income return creates alpha in a
diversification strategy. Many private investors also could not
resist the juicy yields available, although several countries
either prevented or heavily regulated access to the asset class.
It was the naughty but nice oasis in a desert of micro-yield.
But Credit Suisse debt not being honored changes the dynamic
drastically.
While this sudden bail-in is not a one-off, it is of a
different scale. The collapse of Spanish retail lender Banco
Popular, which was swallowed up by Banco Santander SA in 2017,
really ought to have served notice. However, with a much smaller
and localized subset of investors affected, it didn’t change the
greed mindset. National champions, like Credit Suisse, are
supposed to be too big to fail.
Regulatory changes since the global financial crisis have
created new bail-in regimes across all major markets that
carefully determines what can happen to subordinated bond
holders in the event of a bank failure. In the Credit Suisse
case, bondholders are helping to bail out shareholders. Equity
investors are getting about $3.2 billion of value, while equity-
like capital bondholders get zero.
The Swiss regulator is crossing a Rubicon here by
foreclosing on this cornerstone of the capital structure of
banks. While the bond prospectuses clearly laid out the risks to
investors, that doesn’t soothe the shockwave. The world of bank
capitalization is about to become a lot more volatile.
To contact the author of this story:
Marcus Ashworth at [email protected]
To contact the editor responsible for this story:
Mark Gilbert at [email protected]
