Credit Suisse’s takeover delivers a shock to bond investors

If the emergency takeover of Credit Suisse by UBS was supposed to calm markets, it is not looking that way this morning. Markets are sharply down in Asia, and the FTSE fell by 1.5 per cent on opening this morning. Banks were the biggest fallers, losing up to 7 per cent of their value. There is a nasty realisation that the contagion from the banking crisis of the past week could have a lot further to spread.

The centre of this morning’s panic are things known as Additional Tier – or AT1 – bonds, about which we are going to hear a lot more in coming days and weeks. This is a class of bond introduced after the last banking crash in the hope of tempting more private capital to prop up the banking system. The peculiarity of these bonds is that they can been converted into equity in the event of the bank getting into trouble – something which can be triggered, for example, by a bank accepting emergency funding from a central bank, as Credit Suisse did last week. AT1 bonds were attractive to investment funds because they offered a higher rate of interest compared with other bonds issued by banks.

And now we are finding out just why. AT1 bonds have allowed the normal hierarchy of creditors to be reversed. When a bank or any other company collapses normally, it is the bondholders who get the first picking at available funds. Only when they have been reversed do shareholders get refunded – if, indeed, there is anything to refund. Yet in the case of the Credit Suisse takeover – which is not even technically a company collapse – shareholders have been fed the scraps ahead of AT1 bondholders. True, shareholders haven’t got an awful lot: the price per share paid by UBS is less than a third of Friday’s closing price. But AT1 bondholders, we have learned overnight, will be wiped out altogether. The total value of the bank’s AT1 bonds was $17.3 billion.

That itself will come as a nasty shock to investors who thought that bond funds offered much greater security than do company shares. In the past two decades, UK pension funds have made a big switch to bonds. But the question now is: just how secure are other banks’ bonds? The total value of AT1 bonds issued by all European banks has been put at $275 billion.  

The wiping-out of Credit Suisse’s AT1 bond investors shouldn’t really come as a surprise. The European banking system has already seen such a wipe-out when the Spanish bank Banco Popular went under in 2017. It was always part of the deal that AT1 bondholders would bear the burden of a banking collapse. Nevertheless, the loss will inevitably lead bondholders to start asking what have they let themselves in for, and how many more AT1 bonds will end up worthless.