Credit Suisse merger with USB could destroy Western bond market after bank zeroed out BILLIONS in bonds
03/23/2023 // JD Heyes // Views

Global financial fallout from the collapse of large banks in the U.S. continues, according to a series of reports this week.

According to analysts cited by Bloomberg on Monday, the proposed merger between Switzerland's two largest lenders, Credit Suisse and UBS, could have an adverse effect on the entire Western bond market, Russia Today reported.

On Sunday, UBS announced its acquisition of Credit Suisse, which was on the verge of insolvency due to a loss of investor and customer confidence, for 3 billion Swiss francs ($3.24 billion) in stock. The Swiss government, which brokered the deal, provided a 9-billion-franc guarantee for possible losses from Credit Suisse assets, and the Swiss central bank offered 100 billion francs in liquidity assistance, the report added.

As a condition of the merger, Swiss financial market regulator FINMA has instructed Credit Suisse to write off around 16 billion Swiss francs ($17.24 billion) of its Additional Tier 1 (AT1) bonds in order to improve the bank's capital and resolve its liquidity issues.

AT1 bonds, also known as contingent convertible bonds or CoCos, are a form of bank debt that can convert into equity or be written off if a bank’s capital falls below a certain threshold. They were introduced after the global financial crisis of 2008 to improve the resilience of banks and limit taxpayer bailouts. AT1 bonds are considered riskier than regular bonds and offer higher interest rates as compensation for the additional risk, added.

Bondholders are set to receive nothing, while Credit Suisse shareholders will receive $3.23 billion under the UBS deal, despite the fact that bonds typically have a higher priority than equities in the banking hierarchy. This has caused discontent among bondholders, who fear that other countries' authorities may follow the Swiss government's example, said the report.


“It’s stunning and hard to understand how they can reverse the hierarchy between AT1 holders and shareholders… Wiping out AT1 holders while paying substantial amounts to shareholders goes against all the resolution principles and rules that were agreed internationally after 2008,” said Jerome Legras, the chief of research at Axiom Alternative Investments, an investor in Credit Suisse’s AT1 debt, noted.

This just makes no sense… Shareholders should get zero… it’s crystal clear that AT1s are senior to stocks,” a stunned Patrik Kauffmann, a fixed-income portfolio manager at Aquila Asset Management, which is another bondholder, told Bloomberg.

There are varying opinions on the write-off of Credit Suisse's AT1 bonds. While some analysts see it as a reasonable move, given that such bonds were designed to transfer risks to investors instead of taxpayers in case of bank failures, bondholders are displeased with the decision. They fear that other countries may also adopt this approach. Some experts believe that this move will either lead to the closure of the AT1 market for new issuance or it will drive up the prices of such bonds due to the increased risk associated with the Credit Suisse-UBS merger, noted.

According to an interview with RIA Novosti, Lawrence McDonald, a former vice-president at Lehman Brothers, has warned that if the US government fails to take necessary measures to address structural problems, approximately 50 regional banks may succumb to the banking crisis, Russia Today noted in a separate report.

“Policy-makers will most likely be forced to introduce a much larger withholding to maintain outflows of deposits from bank accounts that significantly exceed $250,000,” he noted.

The global financial crisis of 2008 began with the collapse of Lehman Brothers, which led to the freezing of funding markets and made it difficult for international lenders to access US dollars, the report noted.

According to McDonald, the current challenges facing the US banking sector are similar to those preceding the collapse of Lehman Brothers. He added that regional banks in the US are expected to lose "hundreds of billions of dollars," with investors likely to shift their funds to larger banks and eventually to treasury bonds.

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