The Swiss Financial Market Supervisory Authority (FINMA) recently confirmed it would write off CHF 16 billion (AU$25.6 billion) in Additional Tier 1 (AT 1) capital notes issued by embattled investment bank Credit Suisse.
The move was designed to ensure local competitor UBS would have enough capital to secure its AU$4.8 billion acquisition of Credit Suisse, helping to fund costs associated with the takeover.
But the move rattled markets, casting doubt over the security of AT 1 investments.
US law firm Quinn Emanuel Urquhart & Sullivan has reportedly held talks with affected bondholders considering the launch of a class action against Credit Suisse.
According to Amy Xie Patrick, head of income strategies at Pendal Group, the contingent convertible (CoCo) bonds — higher yield bank instruments with no maturity date — are “close to the bottom of the capital stock”, being the first to absorb losses off the back of banking volatility.
Typically, the asset class is available to a narrow pool of sophisticated investors.
“AT1 bonds issued by European and US banks have large minimal parcel sizes for investors,” she said.
“This is the regulators’ way of acknowledging the highly risky nature of these securities. Only large wholesale or institutional investors are able to invest in hybrids offshore.”
This allows smaller mum and dad investors to hedge their risks, investing in a fund or ETF with hybrid bonds included in the mix.
“This, at least, would get them some diversification benefit versus putting all their eggs in one basket.
But in Australia, retail investors are the “primary audience for hybrids”.
“Minimum investments for CoCos are small, to allow mums and dads to directly access this asset class,” Xie Patrick observed.
“The CoCo protestors in the Credit Suisse case are banks, hedge funds, and big private wealth clients all chasing yield over the last decade.
“The ones left holding the bag if any of our Aussie banks get into trouble would be retirees thinking they had bought ‘safe’ bonds.”
The Pendal analyst acknowledged Australian banks are well placed to absorb the impact of market volatility, buoyed by regulatory safeguards introduced following previous global financial crises.
“Fortunately, the Australian financial system and banks are in rude health, thanks to the relatively risk-averse nature of our banking and regulatory institutions,” she continued.
“Our regulator and central bank have a huge library of ‘dos and don’ts’ to draw upon from offshore crisis experiences.
“That was one of the reasons the RBA was able to pull out the stops of quantitative easing and the term funding facility so quickly in the initial throes of the COVID pandemic.”
But the Credit Suisse write-off should serve as a warning for Australian bondholders.
“…The wiping-out of Credit Suisse AT1 bondholders will be a wake-up call for parallel assets in Australia,” she said.
“In coming days, the market will be rightly asking whether the risks have been adequately priced in to domestic subordinated bank bonds.
“Is the market making the right assumptions about call dates and maturity dates? Do hybrids pay enough extra coupon for the risk that those coupons might be switched off? Are there ways to construct portfolios that offer better sleep at night?”
Given the higher stake, Xie Patrick said she expects Australian investors are likely to demand higher returns for future hybrid bond exchanges.
The European Central Bank (ECB) criticised the Credit Suisse write-off in a joint statement alongside the Single Resolution Board (SRB), and the European Banking Authority (EBA).
Pointing to reforms recommended by the Financial Stability Board following the GFC, the European regulators stressed common equity instruments should be the first to absorb the losses of a troubled banking institution, before considerations of a wipeout of AT 1 capital notes.
But common equity shareholders are set to recoup part of their investments in Credit Suisse, with UBS offering one UBS share for every 22.48 Credit Suisse shares, representing approximately CHF 0.76 (AU$1.22) per share.
