How $17 Billion Turned into Nothing Overnight
Credit Suisse Bank News
When the Swiss financial regulator (FINMA) announced that they had brokered a deal for the largest Swiss bank (UBS) to buy out the 2nd largest bank, they also announced that in the deal some bondholders would lose out on their investments.
Bondholders of what are called AT1 Bonds or Additional Tier 1 bonds got the bad news in the midst of efforts to shore up confidence in the bank and brokering the buyout deal.
It must have really hurt because these bonds were worth $17 billion. And all of that value suddenly became zero.
Bond, AT1 Bond
AT1 Bonds, are a type of perpetual bond, which means that they have no maturity date, and they basically pay interest indefinitely, as long as the bank is still in business.
AT1 Bonds are a relatively new and kind of unique type of bond, as they are designed to be a form of “contingent capital” for banks. This means that if the bank experiences financial difficulties, the AT1 Bonds can be converted into common equity shares, which can help strengthen the bank’s balance sheet and improve its financial position. These bonds were designed to help protect tax payers from having to jump in and save banks who get into trouble.
They are designed to bring more money into the bank (to use to invest etc) and are built to absorb impact if things go wrong by being able to be converted into common equity shares.
What Are ‘Common Equity Shares’?
Common equity shares, also known as common stock, are units of ownership in a company.
When you buy common equity shares in a company, you become a partial owner of that company, and are get a bit of its profits. Common equity shares also give shareholders the right to vote on certain company matters, such as electing the board of directors or making major business decisions.
Usually Shareholders Get Shafted
What is unusual here, in the case of the Credit Suisse and USB buyout, is that the whole thing happened so fast that the bondholders were left with nothing overnight (something that the banks and Regulator say was written in to the bonds from the start as a possibility).
Typically, bondholders get something if things go wrong. Normally, it is the shareholders that end up losing out. This time things have played out the other way around.
‘This time things have played out the other way around’
Because of their unique perhaps more risky nature, AT1 Bonds tend to offer higher payouts than other types of bonds.
It’s also worth noting that AT1 Bonds, due to their complexity and risk profile, are typically only available to big institutional investors, rather than individual retail investors.
Angry Bondholders Head To Court
A number of Credit Suisse AT1 bondholders have said that they are starting legal action over their losses.
They say that ordinarily, in the event of a bank failure, AT1s should be prioritized above equity holders. So, they are hoping to head to court to force the bank to settle or to try and reverse what has happened.
Obviously, the banks and the Regulator probably expected this but probably feel that it is better to push the deal now and deal with the consequences later. Hopefully, after the banking crisis has died down.
Why This Matters To You
The Credit Suisse write-down represents the largest loss ever inflicted on AT1 investors since this type of bond was created.
The decision by the Swiss authorities to upend the long-established norms and to rather hit AT1 bondholders instead of other investors has been criticized by some for damaging confidence in this type of bond.
‘the thing is that, a lot of investors have put money into this type of bond at banks around the world’
And the thing is that, a lot of investors have put money into this type of bond at banks around the world. And the banks have all used that money to invest and grow etc.
So, now people are worried this will make these types of investors want to pull out of this type of bond, which would mean that banks everywhere will need to pay them off and come up with that money. Which could place them under incredible financial strain and could make those banks start to fail (maybe).
Image credit: Bond- modified from image by ShareAlike 3