Credit Suisse AT1 wipe-out "negative surprise" for credit market

(Alliance News) - AT1 bondholders being left penniless after Credit Suisse Group AG's buyout was a surprising outcome that could have negative implications for European banks and put creditor hierarchy in focus, analysts at JPMorgan commented.

The UBS Group AG deal to acquire Credit Suisse resulted in USD17 billion of bonds being wiped out.

"In our view, the decisions over the weekend to write-down AT1 while valuing the equity at CHF3 billion could lead to contagion for wholesale funding costs across the sector with around EUR202 billion of AT1 outstanding from European banks and upcoming optional call of over EUR23 billion this year. The issue is the uncertainty around creditor hierarchy, given AT1 took a higher loss relative to equity, which was a negative surprise for the credit market," JPMorgan analysts commented.

AT1 bonds were introduced in Europe after the global financial crisis in 2008 to serve as shock absorbers when banks start to fail.

They are designed to impose permanent losses on bondholders or be converted into equity if a bank's capital ratios fall below a predetermined level, effectively propping up its balance sheet and allowing it to stay in business.

JPMorgan analysts added: "While most banks were paying 8-10% coupon cost in recent issuance of AT1, we expect that credit investors are now likely to demand a higher risk premium across the spectrum, with cost of AT1 issuance potentially rising into double digits. This implies even more pressure on funding costs and deposit betas and is likely to reduce net interest income sensitivity further in our view. Overall, we expect higher cost of equity for the sector, moving well into double digits as AT1 costs move up materially from here.

"We highlight that according the terms and conditions of Credit Suisse's AT1 instruments, there was a provision that requires their write-off upon the occurrence of a 'viability event' which occurs when 'CSG receives an irrevocable commitment of extraordinary support from the public sector'.

JPMorgan noted the Banco Popular rescue deal by Banco Santander SA also resulted in AT1 bonds being written down, though in that case, the equity value was also wiped out, unlike at Credit Suisse.

Analysts at RBC said the insurance sector is unlikely to come under the cross-hairs of Credit Suisse AT1 turmoil.

"Firstly, we note that nearly all AT1 debt is NOT matching adjustment eligible given the non guaranteed nature of cash flows (eg if the conditions are met such that the bonds convert to equity), and therefore is unlikely to be invested in by European insurers," RBC said.

"Further, given CS AT1s were rated at CCC- (ie sub investment grade) and the credit quality has been declining for a number of years, insurers would have been highly unlikely to invested in these assets given the associated capital charge."

By Eric Cunha, Alliance News news editor

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