The Swiss authorities can put it however they want, but what they have done to save Credit Suisse, for the market, is a bit like changing the rules of the game while you are playing. A fact that leads back to that fragile feeling of trust that governs all relationships, financial ones in particular.
Swiss regulators, in an attempt to patch up the management of one of their banks, have decided to cancel d'emblée a type of bond (AT1s, which are part of the category renamed CoCo bonds) for 16 billion Swiss francs and to save instead, albeit for the skin of the cuff, the equities.
The reversal of hierarchy has led to a loss of trust in these tools
No one expected such a reversal of the hierarchy indicated by the BRRD (Bank resolution regulatory directive) in the event of a bailin. All the more from a country that has always held its pride, as well as with chocolate and watches, precisely with the banking system. And there are many who think that those types of bonds have lost their value, even regardless of the specific case of Credit Suisse, and that they will be abandoned.
She even intervened there'Eba, the European banking authority, de facto reminding the Swiss authorities of respect for the hierarchy: “ordinary capital instruments are the first to absorb losses and only after their full use would it be necessary to proceed with the devaluation of the Additional Tier One” he said this morning. In fact, the hierarchy provides for a risk scale, at the top of which there is Common Equity (shares), then Preferred Equity and Additional tier 1 (At1), then Tier 2 issues, subordinated debt ), senior unsecured debt, deposits and senior secured debt.
Lagarde: Eurozone banks have ratios even higher than legal requirements
The shock has spread to all types of markets, with losses even in the 2-digits this morning due to the fear of contagion. Then, slowly the recovery. The recurring question is whether, and to what extent, the European banking system can be involved. Obviously, the utmost caution prevails.
The president of the ECB Christine Lagard, he said today that developments in the international financial markets, in the euro area and in the banking sector are being “closely monitored, from the point of view of financial stability. The ECB has also launched some stress test on banks: and “we are very confident that the capital positions and liquidity ratios of euro area banks are very satisfactory given that the capital and liquidity coverage ratios are in excess of legal requirements.
Reassurances also arrive on the Italian front
"The disruptions" generated by Svb and Credit Suisse "are in areas with which we have a lot to do" but "the European financial system is not directly involved", said the Governor of Bank of Italy, Ignatius Visco. He's of the same opinion too Giancarlo Giorgetti, head of the Ministry of Economy, who this morning said on the sidelines of an Intesa Sanpaolo appointment at the Cariplo foundation that "we are calm for the Italian banking system, the repercussions for the Italian banking system I believe are completely insignificant".
Expected waves of legal appeals
There are many on the market who believe that the Swiss authorities will soon be flooded by thousands legal appeals that “they will force them to revise their positions” says a strategist. "It won't be easy, but there are legal loopholes." Rbc analysts, on the other hand, believe that it is not possible because the decision to cancel them was taken by the Finma, the Swiss Consob, which acted on the basis of the Point of Non Viability clause. This is a situation where a bank or other regulated institution experiences severe financial stress due to insufficient liquidity or capital, resulting in seizure and resolution by the regulator.
But it is the Swiss authorities themselves who are responding: "At first it was a question of finding a solution for the protection of savers and the image of the Swiss financial centre", says a spokesman for theFederal authority supervisory authority on the financial markets (Finma), adding: "Secondly, other issues will have to be clarified".
The market recovered much of the morning's deep red in the evening
Meanwhile, on the bond market, after a frightening slide in the first part of the session, now, in parallel with what is happening on the stock market, we are seeing a recovery.
Taking the Invesco AT1 ETF as an example, after opening 15% down, it lost 11,6% in the mid-morning and reduced the losses to 5% towards the close. “There's a good chance that losses in the next few hours will be wiped out entirely,” says another strategist. “The eurozone banking system is much more controlled than that of other non-EU countries” says Giacomo Alessi, independent strategist. “I would also add that the Italian banking system in particular is particularly strong”.
Certainly not, Credit Suisse's $1 billion AT1 bond with a 4,5% coupon is offered down to 1 cent, as reflected by Tradeweb pricing.
What are At1 bonds
Of course, it is a very particular type of subordinated (and therefore non-senior) bond, aimed mostly at institutional investors: normally the minimum subscription value of these securities is 200.000 euros. “This may have been one of the reasons behind the decision to prefer the elimination of these assets instead of the shares which instead can also be in the hands of non-professionals” says Alessi. “Although, he adds, among those canceled there is also a Swiss domestic bond that had a minimum denomination of 5.000 Swiss francs and which could therefore have gone into the hands of the retail investor“ he says.
This type of bond can be perpetual, i.e. without a precise repayment date but established at the issuer's discretion. In case of loss, they pay no coupon. So for the bank, it's about one capital defense tool. These bonds were born as part of the Basel III Accords of 2009 when regulators asked banks to increase the ratio of Tier 1 capital to risk-weighted assets with a new class of securities called Additional Class Capital 1 (AT1 bonds). They may automatically lose value if one of the key factors of the issuer's financial strength falls below a certain level.
A total market worth 275 billion dollars
These tools used to be an expensive, but convenient, crutch in case of capital needs and many think this type of tool may no longer be used. An estimated $275 billion in banks and hedge funds are currently in circulation, strategists say A further question is whether any institutional investors are particularly exposed to Credit Suisse's $16 billion issue themselves becoming a new front in the crisis financial. Certainly this is the largest loss in the AT1 debt market, surpassing the €1,35 billion lost by bondholders of Spain's Banco Popular in 2017.
What happened to the pecking order could in the future lead bank issuers to offer such a high yield on these bonds, that a capital increase may even be preferable, according to experts.
