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When characteristically risk averse fixed income investors lose money, they are usually not happy. When they lose CHF 16 billion, they are very sad. The writing down to zero of the AT1s of Credit Suisse brought home to bond investors, the number one priority of regulators. At least Swiss ones, as in FINMA.
The investment manager research inside RFPnetworks focuses in detail on three questions:
Some argue that UBS, together with the Swiss Government, bailed out Credit Suisse equity holders at the expense of debt holders. Put differently, AT1s were subordinated to the firm's equity, which should be the most subordinate part of the capital structure, behind Tier 2 and other subordinated debt. For some, this legal argumentation is weak, as Swiss AT1s are not the same as EU/UK AT1s. Just read the terms and conditions.
In any case, expect long drawn out legal battles as was the case with Banco Espirito Santo in Portugal. Or is - they are still going on today.
This is not the first time this has happened - recall Banco Popular. It just happens to be more controversial and the largest since the beginnings of the AT1 market in 2014. Some argue that this event will increase the cost of bank refinancing via AT1s (and therefore reduce earnings). Or at the extreme, that investors will leave the market. Opinions across investment mangers vary widely, depending on whether they held Credit Suisse AT1s.
The ECB reacted very quickly with a clarification statement to soothe EU AT1 debt holders. In clear language, the ECB declared that equity is the most subordinate security in the capital structure. Vive la difference!
Selling and contagion characterised the immediate market reaction to FINMA's decision. The CoCo Index excluding Credit Suisse bonds was trading in the low 80's. Of the 200 AT1 bonds outstanding, not a single issue was trading above par. In effect, AT1s were being priced to perpetuity at ~9%. In other words, no-one expects these AT1s to ever be redeemed. If this highly unusual scenario were not true - which some investment managers believe is highly possible - the resulting yield on first call was closer to 12%.
Tragedies often start with an unexpected catalyst and end in irony. In the case of the unexpected catalyst of Credit Suisse AT1 zeroing, the irony is that it may be a good time to speak to subordinated debt investment managers. Just make sure they are good at reading terms and conditions. If in doubt, source wider inside RFPnetworks.
