So much going on in banking; so many lessons and precedents. The way in which Credit Suisse’s Additional Tier 1 securities were applied (and equally as importantly) the way the market reacts is one I think is definitely worth watching.
It was easy to miss this detail given how much has been going on but John Authers (Bloomberg Opinion) neatly sums it up …
Holders of “Additional-Tier 1 (AT-1)” bonds have been wiped out. Credit Suisse’s roughly 16 billion Swiss francs ($17.3 billion) worth of risky notes are now worthless. The deal will trigger a complete writedown of these bonds to increase the new bank’s core capital — meaning that these creditors have had a worse deal than shareholders, who at least now have some stock in UBS.
Bloomberg Opinion “And then there was one”, Points of Return, John Authers 29 March 2023
The relative treatment of shareholders and AT Creditors was, for me at least, a surprise. In the conventional capital stack, shareholders absorb losses before all stakeholders. I did a post here setting out my understanding of loss absorption under bail-in. Christopher Joye helpfully explained that the Swiss seem to do bail in differently …
In contrast to many other bank hybrids, including those issued by Aussie banks, CS bank hybrids cannot, and do not, convert into equity in this scenario (ie, Aussie bank hybrids are converted into equity before a write-off). Instead, the CS hybrids must legally go directly to write-off. They further do not permit any partial write-off: the only option is for the regulator to fully write-off these securities.
“UBS buys Credit Suisse in CHF3 billion deal, bonds fully protected as AT1s are zeroed” Christopher Joye, Livewire 20 March 2023
John Authers offers some more context …
“Additional Tier 1” capital was a category introduced under the Basel III banking accords that followed the GFC, with the intention of providing banks with more security. Holders of the bonds were to be behind other creditors in the event of problems. In the first big test of just how far behind they are, we now know that AT1 bondholders come behind even shareholders.
…. he goes on to note that, while limiting moral hazard requires that someone be at the pointy end of loss absorption, the Swiss precedent poses the big question – who wants to buy Swiss style Additional Tier 1 knowing what they know now …
This follows the logic of the post-crisis approach, and it limits moral hazard. The question is whether anyone will want to hold AT1 bonds after this. The market response will be fascinating, and it remains possible that the regulators have avoided repeating one mistake only to make a new one.
The Swiss logic of favouring shareholders is not obvious to me so maybe I am missing something. It might offer some short term advantage but I am with John Authers on this one. Who signs up for this deal next time. We are definitely living in interesting times.
Tony – From the Outside
From the outside 