Credit Suisse crisis: How AT1 wipeout could impact the global bond market

This is the biggest wipeout yet for Europe’s AT1 market, overshadowing the only other write-down of this type of security — a $1.45 billion loss for bondholders of Spanish lender Banco Popular in 2017, when it was taken over by Banco Santander to prevent a Credit Suisse-like collapse.

But there is a crucial difference. In the Banco Popular case, alongside bonds, equity was also written off; the Credit Suisse-UBS deal brokered by the Swiss financial regulator FINMA entails a complete write-down of the bank’s AT1 bonds, even as equity shareholders are set to receive about 3 billion Swiss francs.

The action reverses what is typically a settled principle of write-downs: shareholders take the hit ahead of bondholders. While AT1 securities are considered the most risky among bonds, in the right-to-payouts list, AT1 bondholders come after senior bondholders but are ahead of equity shareholders — who are theoretically exposed to losses upfront.

Reuters reported that UBS CEO Ralph Hamers told analysts that the decision to write down the AT1 bonds to zero was taken by FINMA, so it would not create a liability for the bank. But the regulator’s action goes against the traditional flow of things and threatens to plunge European bond markets into turmoil.

Bond market impact

At nearly $130 trillion, the global bond market far outweighs the stock market in size, and plays an outsize role in the global financial system, especially in the way governments raise funds to manage their deficits. Rumblings in the bond markets could make it harder for other lenders to raise new AT1 debt, especially when the financial sector is facing tough times. AT1s, introduced in the aftermath of the 2008 global financial crisis as a bankable debt market instrument, pay higher interest as they carry greater risk than regular debt.

Following FINMA’s announcement of the CHF 16 billion (about $17.3 billion) write-down of Credit Suisse’s AT1 bonds, European and Asian AT1 bonds tanked on Monday. UBS’ AT1s with a 2025 call slid to around 85 cents on the dollar compared with 93 cents on Friday, according to Tradeweb data quoted by Reuters.

European vs US crisis

There are specific, and somewhat distinct, triggers for the unfolding banking sector crises on either side of the Atlantic. Credit Suisse was partly a victim of bond market losses, but multiple other factors were at play in its downfall: a poor governance record and chequered investment decision-making, which saw the bank lurching from scandal to scandal over much of the last decade, and it was repeatedly categorised as Europe’s weakest “systemically important” bank.

In the US, the triggers were different. Over 90 per cent of deposits at Silicon Valley Bank (SVB) and Signature Bank were uninsured, and thereby prone to bank runs. These banks were also invested heavily in long-term government bonds — and when interest rates rose, the value of their bond portfolios declined. They sold some bonds to raise funds, and when these losses came to light, panicky depositors rushed to pull out.

There was also an asset-liability mismatch in SVB’s case: being overly exposed to the same profile of funders and customers — venture capital funds and start-ups.

Troubles in the banking sector and the wider bond market are likely to be high on the agenda of the US Federal Open Market Committee (FOMC) meeting on Wednesday. This is especially important as analysts point to a soft landing of the economy as being less of a possibility today than recessionary risk.

Impact on Indian banks

The decision to write down Credit Suisse’s AT1 bonds to zero after the lender’s takeover by UBS may contribute to a higher cost of capital for banks, including Indian lenders, S&P Global Ratings said on Tuesday. The write-down will weigh on the pricing of such notes and spook investors, Citi analysts said in a note.

In India, AT1 bonds of Yes Bank were written down in March 2020 after the Reserve Bank of India initiated a restructuring of the troubled lender. Since then, Indian banks have raised AT1 bonds at an up to 75 basis points premium over government bonds, Citi noted.

Some bankers, however, do not see a major impact on the fundraising capabilities of Indian banks through AT1 bonds — one reason for the optimism is that the spread between regular bonds and AT1 bonds in India is less than 150 basis points, while in the EU and the US, it is 200-250 bps. Jefferies said in a note that Indian lenders have “limited dependence” on such securities.

S&P noted that Indian lenders are capable of “enduring any potential contagion effects” emanating from the US banking turmoil and the Credit Suisse episode “given their manageable exposures” to global counterparts. “Strong funding profiles, a high savings rate, and government support are among the factors that bolster the financial institutions we rate,” the rating agency said, adding that domestic banks had sufficient buffers to withstand losses on their government securities portfolio due to rising interest rates.