In part 2 of the Credit Suisse bailout saga, we uncover the truth behind the controversial decision to impose losses on Credit Suisse’s additional tier 1 capital bonds. We explore what AT1 bonds are, why they were written down, and whether it was fair to bondholders. If you missed part 1, please click here. The regulators urged UBS to increase their price, putting pressure on both sides. UBS offered $3.25 billion in stock, but they demanded more government support, including a 100 billion Swiss Franc liquidity line from the Swiss National Bank and a government loss guarantee of up to 9 billion Swiss Francs. UBS agreed to bear the first 5 billion Swiss Franc loss itself. Time was running out, and Credit Suisse was furious about how things were unfolding. Despite their offices being located facing each other across a square in Zurich, both sides had not even sat down together. The Swiss government modified the deal to make it more palatable for Swiss citizens and the bank’s equity investors. They decided to impose just over $17 billion in losses on Credit Suisse’s additional tier 1 (or AT1) capital bonds. The bond documentation in this case specifically states that a write-down may occur even if existing preference shares, participation certificates, and ordinary shares of Credit Suisse Group remain outstanding. The fact that this provision existed in the bond contract allowed Swiss authorities to disregard the normal order of priority, likely to save face with international equity holders after denying them a vote on the transaction. Credit Suisse’s board consulted with their advisors and signed the deal. The Swiss finance minister said at a press conference that “This is no bailout, this is a commercial solution.” The Chair of Credit Suisse stated that “Given recent extraordinary and unprecedented circumstances, the announced merger represents the best available outcome.” Kelleher from UBS acknowledged that it was a historic day he had hoped would never come. He clarified that the acquisition is attractive for UBS shareholders, but it is an emergency rescue for Credit Suisse. The resulting combined bank will be of even greater systemic importance, given that each individual bank was already deemed “too big to fail.” UBS will have a near monopoly in Switzerland, raising concerns about potential problems for Swiss bank customers or the possibility of the new entity being slowly broken up in the future. UBS will need to ensure that its capital ratios are high enough to support the much larger bank. They confirmed that “the bank remains capitalized well above its target of 13%.” Swiss regulators announced that “the takeover will result in a larger bank, for which the current regulations require higher capital buffers,” but they “will grant appropriate transitional periods for these to be built up.” The Swiss government has been criticized by bondholders and international regulators for its handling of this shotgun wedding. The decision to favor shareholders over bondholders raised concerns among investors in similar bonds issued by other banks, worrying that they too could be sacrificed in a similar scenario in the future. Shareholders of the selling bank usually receive some payment, not necessarily because their shares have any significant value, but because the deal is technically voluntary, and it is challenging for the board of directors of the selling company to announce that they negotiated the best possible price for shareholders and got nothing for them – not even a little Swiss chocolate.
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Let’s review the AT1 bonds. What are they, and is it fair what happened to the bondholders? After the credit crunch, regulators wanted to reduce the risk of a systemic bank failure on depositors and taxpayers by transferring more risk to bondholders. These bonds were seen as a way to strengthen bank balance sheets and reduce the need for taxpayer-funded bailouts in the future. These bonds are perpetual with a fixed face value and make regular interest payments. The bank doesn’t have to pay back the principal amount, but they can after five years, and they usually do. If the bank’s common equity tier 1 capital ratio falls below 7%, the AT1 bond gets written down to zero. This improves the bank’s balance sheet as a big chunk of debt disappears. However, some AT1 bonds convert into common stock when the trigger is hit, while others are temporarily written down and stop paying interest when the trigger is hit. Some investors feel that these bonds should have been senior to equity, but they are not. The name “7% CET1 trigger write-down AT1 bonds” means that if the bank’s common equity tier 1 capital ratio falls below 7%, the bonds are written down. The bond prospectus, which can be found on the Credit Suisse website, also states this. This structure has not been hidden, some investors chose to ignore it. Credit Suisse issued an AT1 bond with a yield of 9.75% last year, and that compensates investors for the risk they are taking in buying a bond like this. If these bonds were the same as regular Credit Suisse bonds, they would have had much lower yields. The bonds’ documentation states that the Swiss regulators may not be required to follow any order of priority, which means the notes could be canceled before any or all of Credit Suisse Group’s equity capital. The prospectus also included a clause stating that the bonds could be written down in a “viability event,” which can include a situation where the bank has received “an irrevocable commitment of extraordinary support from the Public Sector.” Some of the owners of these bonds may have been senior management and employees at Credit Suisse. Stay tuned for part 3.
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