Credit Suisse and the AT1 bond sinkhole
The bailout deal following UBS’s purchase of Credit Suisse has caught AT1 bondholders by surprise and thrown a bond market worth 275 billion euros into turmoil. The Swiss bank’s subprime bonds, which had a face value of around 16 billion euros, are now worth exactly zero euros.
Investors in AT1 bonds have panicked after the Swiss Financial Markets Supervisory Authority (FINMA) announced that UBS’s purchase of Credit Suisse will result in a full redemption of the face value of all debt of this type of bond, also known as contingent convertible bonds or CoCos.
These AT1 bonds were introduced after the 2008 financial crisis and were intended to reduce the likelihood that, in the event of a bank failure, the taxpayer would have to pay for the bailout. They are essentially high-risk bonds that are converted into equity if a bank falls below a certain capitalisation limit, offsetting losses.
The announcement by the Swiss National Bank (SNB) that UBS would buy Credit Suisse for 3.01 billion euros, less than half of what the bank was worth at the last stock market close, represented a significant devaluation in the value of the shares. The surprise, however, was that with the purchase and rescue agreement, AT1 bonds were written down to zero, losing their nominal value of some 16 billion euros.
Alarm bells rang among investors in the AT1 market
Predictably, the nervousness among holders of AT1 bonds of other banks has become apparent in the face of the possibility of losing their investments in the event of a bank collapse. This puts a 275 billion euro AT1 bond market in jeopardy and is expected to force banks to raise the risk premium on these investment products.
The president of the European Central Bank (ECB), Christine Lagarde, sought to reassure investors who see an increased risk of large losses as part of any bailout, saying that “Switzerland does not set standards in Europe” in terms of conditions for bailing out banks.
It should be borne in mind that in Spain alone, large banks hold some 22 billion euros in contingent convertible bonds, CoCos. These are mainly distributed among the assets of Banco Santander (7,811 million), CaixaBanc (5,000 million), BBVA (5,000 million) and Banco Sabadell (1,750 million). It remains to be seen whether the high market volatility, marked by the banks’ liquidity problems that have grabbed the headlines in recent days, will be exacerbated by the support measures adopted to minimise its consequences.
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