With the news out Sunday March 19th, that UBS would be acquiring all of Credit Suisse for $3bln (all paid to the common equity), there are plenty of head’s shaking across the bond world today.
The reason being is that the Swiss Regulator allowed for the complete wipeout of “(more) senior bonds” (being the Alternative Tier 1 Capital Securities, some $17bln worth), while the, technically, subordinate common equity would be receiving $3bln. Crazy? Sort of, but those Swiss AT1 securities allow for such permanent impairment and subordinate payments to the common stock. Typically, bonds are more senior to common equity and should receive more in light of a restructuring or bankruptcy filing. Not so in the Swiss AT1 securities. Likely also being driven by CS’s largest shareholders (Saudi’s and Qatari’s…who both are likely huge depositors in CS’s Wealth Management arm).
To be fair, AT1 securities in Canada do not allow for such subordinated payments, like those in Switzerland (and Europe, but less so than in Switzerland). Nonetheless, the C$ AT1 securities (called LRCN – Ltd Recourse Capital Notes) are lower by about $5 or about 5% or about 250bps on a marked-to-market basis. That hurts for a so-called “stable” bank bond. And this will make funding for all banks more expensive, which is not good for banks, in general.
Since Basel III (new global bank regulations) came into effect (2013 and rolled out through 2020, I believe), there has been substantially more risk to investing in bank securities across all parts of the capital structure, from Senior Bail-in/NVCC bonds through to Common Stock. It has created asymmetric risk compared to pre-Basel III, as some CS AT1 bond holders just found out the hard way.
For this reason, over the last 8 years, High Rock has entirely avoided all Canadian Bank Bail-in/NVCC bonds and AT1 (LRCN and Preferred Shares) securities in all our mandates (no bonds, no Preferred shares, no LRCN bonds and we have only “traded” Canadian Bank common Equity once during the initial Covid-19 sell-off). Understanding the inherent risk in any investment is key – simply saying “well, the bonds/prefs are from a big bank (Swiss or Canadian) so they are safe” is, quite frankly, not near enough. Research is required…something we do.