The ramifications of the decision by the Swiss Financial Market Supervisory Authority (Finma) to wipe out Credit Suisse’s $17bn of additional tier-1 (AT1) bonds were immediate and are likely to be enduring.
Ten days after the 19 March announcement was made that the bonds were worthless, an Invesco exchange-traded fund tracking AT1 debt had fallen 19%. At the beginning of April, Mitsubishi UFJ Financial Group postponed its planned issuance of AT1 debt, citing poor investor appetite and dire market conditions.
As PGIM Fixed Income portfolio specialist Gabriel Doz told Citywire Asia: ‘The AT1 bank debt market is now in a coma.’
‘The yields were attractive, but we never went down the capital structure on banks’
Gabriel Doz, PGIM Fixed Income
Capital structure ambiguity
Also known as contingent convertibles, or Cocos, AT1 bonds can be converted into equity if capital ratios fall below a certain level or are written down entirely. The bonds form part of a bank’s tier-1 capital, the core measure of a lender’s financial strength, which also comprises common equity tier-1 capital.
Doz noted that the AT1 wipeout, which formed part of Credit Suisse’s enforced takeover by UBS, only affirmed PGIM fixed income’s stance of staying away from the sector. ‘The yields were attractive, but we never went down the capital structure on banks,’ he said.
The $275bn AT1 sector is a product of the global financial crisis in 2008, derived from regulators’ desire for banks to move risk away from depositors and to have greater capital requirements in case of failure. AT1 bonds typically pay higher yields and are periodically called, giving investors the possibility of an early exit.
Although debt typically ranks above equity in a restructuring, Finma overturned the order of priority by giving CHF 3bn ($3.3bn) back to Credit Suisse shareholders while wiping out AT1 bondholders.
‘The Credit Suisse acquisition raises questions on the positioning of AT1 in the capital structure,’ said Riad Chowdhury, head of Apac, MarketAxess, in a note.
Indeed, the AT1 bond market faces a ‘risk premium repricing’ in the wake of Credit Suisse’s debt being written down ahead of equity. Some banks will struggle to issue and others will pay a much higher price to tap the market.
Kian Abouhossein, European banking analyst at JP Morgan, noted that most banks were paying 8-10% coupons for AT1 bonds but should brace themselves for this potentially rising into double digits.
AT1 bonds are perpetual, meaning the borrower has no obligation to repay investors. However, banks typically refinance the bonds with new issuance once an initial ‘non-call period’ has expired, providing flexibility to investors who can decide whether to invest in the new debt.
More than $37bn worth of AT1 debt issued globally has call dates in April, according to Refinitiv data. If banks decide not to call their debt, yields in the AT1 market could surge even higher.
‘There is going to be a heightened focus on investing in the strongest banks’
Riad Chowdhury, MarketAxess
Asia bank issuance
Yet, despite the shock to the wider market, the reverberations in Asia Pacific have so far been muted, notwithstanding the delay in Mitsubishi UFJ’s launch.
Asia’s AT1 bond prices dropped 4.3% on average, lower than the double-digit declines in many other markets, according to data compiled by Natixis Corporate & Investment Bank between 17 and 21 March.
‘A lot of the AT1 issuance within Asia had a huge derating, [and] we thought there were opportunities,’ said Omar Slim, co-head of Asia ex-Japan fixed Income and portfolio manager at Pinebridge. ‘But the timing has passed in the sense that the selloff in Asian financials was really short-lived and came about very quickly. There was a window of only three or four days.’
There are $69bn worth of outstanding US dollar-denominated AT1 bonds from Asian Pacific banks, according to Goldman Sachs estimates, with mainland Chinese institutions accounting for 41% of the total. European banks account for the majority of the bonds outstanding.
‘Immediately [after Finma’s decision], there was a sharp selloff in AT1 bonds of Asian issuers as investors panicked that these securities could be subordinated to equities in certain situations,’ said Chowdhury.
Although prices recovered, he warned that ‘there is going to be a heightened focus on investing in the strongest banks’.
Indeed, Natixis also cautioned: ‘A likely scenario is the financial sector will need to pay a higher cost when raising capital, which will also affect Asia, and it can lead to a selective approach and more constraints on credit growth ultimately.
‘There is also likely to be a re-pricing of the asset class where increasingly investors will compare AT1 yields to the cost of equity. This repricing of AT1 securities will likely cause some issuers (certainly the weaker ones) to consider calling back their AT1 bonds and consider other sources of (cheaper) capital,’ said Natixis.
‘This might reduce the investable universe of AT1 bonds available to Apac-based investors,’ said Chowdhury.
‘The bonds were sold on the promise that they were high yielding and safer than equities, but it has been a rude awakening for private banking clients and advisers’
Singapore-based private banker
Regulatory reassurances
Regulators elsewhere, however, have distanced themselves from Finma’s decision, which might calm investors and reopen the AT1 market for issuers.
The Swiss regulator said the Cocos issued by Credit Suisse ‘contractually provide that they will be completely written down in a “viability event”, in particular if extraordinary government support is granted’.
Emergency government loans were granted to the Swiss bank on 19 March as part of the financing package for UBS’s $3bn takeover, triggering the viability event clause.
However, the European Central Bank (ECB), Monetary Authority of Singapore (MAS), Hong Kong Monetary Authority (HKMA) and Bank of England (BoE) have publicly stated they will rank AT1 holders above equity investors.
‘Shareholders are the first ones to absorb losses, followed by holders of AT1 and tier-2 capital instruments,’ HKMA said in a statement.
BoE governor Andrew Bailey said that ‘in any resolution we will always abide by the creditor hierarchy because that’s a cardinal principle’, while the ECB affirmed that ‘common equity instruments are the first ones to absorb losses’.
‘It was very positive for the market as well as for Asian issuers and investors, that the ECB confirmed that CET1 would be the first to take losses and that it would not be following what the Swiss did,’ said Chowdhury.
MAS joined the reassuring chorus by stating that, in exercising its powers to resolve a financial institution, it intends to abide by the hierarchy of claims in liquidation.
MAS also clarified that AT1 bonds in Singapore are offered in the wholesale market, which is only for institutional and accredited investors, in transactions of at least S$200,000 ($150,600). It said that no prospectus for the offering of AT1 bonds to retail investors has been registered with the MAS.
‘Shareholders are the first ones to absorb losses, followed by holders of AT1 and tier-2 capital instruments’
Hong Kong Monetary Authority
Recovering losses
However, it is unlikely that all institutional and accredited investors will resign themselves to their losses.
‘The decision by the Swiss regulator and the subsequent impact it has had on the market has caused anxiety among private banks who were pushing these products to their wealthy clients,’ a Singapore-based private banker told Citywire Asia.
‘The bonds were sold on the promise that they were high yielding and safer than equities, but it has been a rude awakening for private banking clients and advisers,’ he added.
Some holders of Credit Suisse’s AT1 bonds have instructed law firm Quinn Emanuel Urquhart & Sullivan to represent them in discussions with the Swiss authorities and possible litigation to recover their losses.
Clearly, the consequences of Finma’s action have not yet fully played out.
