In a move that enraged investors on Sunday, Credit Suisse announced that 16 billion Swiss francs ($17.24 billion) of its Additional Tier 1 debt will be written down to zero as part of its rescue merger with UBS.
The decision, according to the Swiss regulator FINMA, will increase the bank’s capital. The action underscores the aim of the authorities to have private investors share in the suffering caused by Credit Suisse’s problems.
The decision was made in accordance with the nation’s “too-big-to-fail” banking structure, according to chair Marlene Amstad.
As a result, it appears that AT1 bondholders are left with nothing, whereas stockholders, who rank below bonds on the priority ladder for recovery in a bankruptcy proceeding, will benefit from the UBS agreement by receiving $3.23 billion.
AT1 bonds are a type of junior debt created in the wake of the global financial crisis that contributes to banks’ regulatory capital. They were created as a mechanism to shift risks from taxpayers to investors in the event that a bank runs into problems.
In the event that a lender’s capital reserves are depleted beyond a predetermined level, the bonds may be converted into equity or written down.
The ability to invert the hierarchy between AT1 holders and shareholders is astounding and difficult to comprehend, according to Jerome Legras, head of research at Axiom Alternative Investments, a company that owns AT1 debt issued by Credit Suisse.
Earlier on Sunday, Swiss authorities were considering taking bondholder losses as part of the rescue plan.
According to Ralph Hamers, CEO of UBS, FINMA made the decision to write down the AT1 bonds to zero so that the bank would not be liable for them.
The price of Credit Suisse’s AT1 debt increased earlier on Sunday as a result of news that shareholders would benefit from a merger with UBS, giving bondholders hope that their interests would be safeguarded.
Prior to the weekend, the bonds had descended into distressed territory as worries about the Swiss lender’s health grew.
According to investors, the Swiss regulator’s action may make it more difficult for other lenders to issue fresh AT1 debt.
As a result of this additional risk, all other banks will have to pay more for AT1 bonds in the future, according to Running Point Capital Advisers partner and chief investment officer Michael Ashley Schulman.
Since AT1s provide a greater risk to investors than conventional debt, they have higher interest rates.
Investors had been concerned that banks would extend outstanding AT1 notes in order to avoid refinancing at worse terms due to higher interest rates prior to the news on Sunday.
