The emergency ordinance enforced by the Swiss government (Federal Council) to grant extraordinary liquidity assistance loans to Credit Suisse has triggered the decision to write down AT1 bonds, the country’s Financial Market Supervisory Authority, FINMA, said today.
Article 5a of the emergency ordinance amended on Sunday 19 March, the day of the announcement of the bank’s takeover by rival UBS, stated under Additional Tier 1 capital (AT1) that at the time of the credit approval, FINMA may order the borrower and the financial group to write down AT1 bonds.
The order given by FINMA to Credit Suisse resulted in losses for bondholders of around CHF16bn, the largest to date on the AT1 debt market. Tier 2 bonds are not written down, the regulator said.
With its decision, FINMA inverted the hierarchy on bearing losses that, according to the capital adequacy ordinance (CAO), sees shareholders carrying losses before AT1 holders.
The Swiss Ministry of Finance (FDF) further explained in a statement regarding the content of the emergency ordinance that the financial regulator could order the write down of additional Tier 1 capital for liquidity assistance approved to avert life-threatening consequences for the capitalisation of Systemically Important Banks (SIB), such as Credit Suisse, supporting the continuation of business activities.
An order under Article 5a can be issued in view of a takeover or sale scenario if insolvency would have taken place without this takeover, the ministry added in the statement.
The Federal Council had obtained the approval of a delegation of the Swiss Parliament in advance for the credit in the emergency procedure, it added.
The government is granting UBS a guarantee in the amount of CHF9bn to assume potential losses arising from certain assets that UBS takes over as part of the transaction, should any future losses exceed a certain threshold.
AT1 bonds, publicly issued by large banks and mainly held by institutional investors, are designed in such a way that they are written down or converted into Common Equity Tier 1 capital before the equity capital of the bank concerned is completely used up or written down, FINMA said.
Pension funds holding AT1 bonds, also referred to as CoCo bonds, can suffer losses as a consequence of the decision taken by FINMA. The pension fund for the city of Zurich (PKZH) has been the only one so far to disclose information on AT1 bonds, saying that it does not hold them in its portfolio.
The Swiss regulator’sdecision to change the rules and subordinate bondholders to shareholders bearing losses led the European Banking Authority and the Bank of England to reassure markets on the merit and hierarchy of AT1s, leading to a rebound after AT1s fell sharply on Monday morning by between 7-15 points with UBS underperforming, Dillon Lancaster, portfolio manager at TwentyFour Asset Management, said in a blog post.
BNP Paribas and Barclays are two AT1 bonds to have recovered, although still down over 10 points from their February highs, and some other like UBS are lagging.
“We would not be surprised to see this continue due to questions over the Swiss regulatory regime. In addition, it appears that legal challenges could be launched from both bondholders and shareholders regarding the Credit Suisse takeover, which could also weigh on performance, although UBS equity has performed strongly,” Lancaster said.
“It’s still an open question why the Swiss authorities decided to write down completely the AT1 bonds of Credit Suisse, but not the equity,” said Klaas Knot, the president of the Dutch central bank DNB, at the bank’s annual press conference this morning.
“I’m interested in the question of why the value of Credit Suisse’s equity was not written down completely, but the AT1 bonds were. I haven’t seen an explanation for this yet,” said Knot, referring to FINMA’s statement.