Credit Suisse AT1 viability-event fine print points to write-down risk
3rd April 2023
Credit Suisse Additional Tier 1 (AT1) bondholder queries persist regarding a “viability event” and whether government support has materially improved the Swiss-headquartered bank capital adequacy. But the bond prospectus covenants warned investors that a full write-down of investments driven by a determination of the Swiss regulator FINMA was possible, according to Fox Legal Training founder and covenant expert Sabrina Fox and three buysiders, with a second lawyer questioning the latest events.
The situation regarding Credit Suisse has been dominating headlines in recent weeks. The Swiss bank on 19 March entered into a merger with Swiss banking peer UBS whereby shareholders would receive one share in UBS for every 22.48 shares held in Credit Suisse as part of a merger consideration of CHF 3bn for all shares in Credit Suisse, while AT1 holders with CHF 16bn notional would be written-off to zero, as reported. Swiss regulator FINMA subsequently noted that bonds would be written down in full as part of a “Viability Event”, particularly if extraordinary government support was provided.
The Credit Suisse USD 1.65bn 9.75% perpetual tier one contingent write-down capital note bond (AT1) prospectus acknowledges prospects of a bondholder write-down in the event of either a Contingency Event or a Viability Event.
A Viability Event is defined as occurring in two scenarios, according to the bond prospectuses. The first scenario is if a write-down occurs due to customary measures to improve Credit Suisse capital adequacy being deemed inadequate and infeasible and the write-down is an essential requirement to prevent Credit Suisse from becoming insolvent, bankrupt or unable to pay a material part of their debts as they fall due. The second scenario where a write-down can occur is if Credit Suisse has received an irrevocable commitment of extraordinary support from the Public Sector that “has, or imminently will have, the effect of improving Credit Suisse capital adequacy and without which, in the determination of the regulator, [Credit Suisse] would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due and unable to carry on its business.”
The USD 1.65bn 9.75% perpetual tier one contingent write-down capital note bond prospectus notes that the occurrence of a Viability Event is subject to a subjective determination by the Regulator and that following a write-down event, the full principal amount of each note will be written down to zero with no right to receive repayment of principal and no right for unpaid interest.
Fox told Debtwire that reading the fine print and understanding the documentary nuance of any legal instrument is key. In the vast majority of cases, the terms of AT1s provide for write-down or convertibility into equity, but it appears that the Credit Suisse AT1s did not contain the latter feature.
The FINMA stance on an AT1 write-downs was in contrast to the EU view on the AT1 bonds with Dominique Laboureix, the Secretary General of the Autorité de Contrôle Prudentiel et de Résolution, assuring AT1 bondholders in European Union (EU) banks that the EU would continue to prioritise their interest over the claims of equity holders, FT.com reported.
“In addition, understanding jurisdictional nuance, and fully grasping the implications of the Swiss government not being bound by EU law, should have informed investors’ risk analysis,” Fox said. “That other central banks and regulators have since made public statements confirming that the same subversion of capital structure priority would not occur in their respective jurisdictions underscores this point.”
Fox noted that contractually, the write-down argument will turn on the presence of a Viability Event, though FINMA’s belts-and-braces approach to the write-down by enacting an Emergency Ordinance on 19 March provides an additional legislative basis for the action. She added that it is important to note that this does not necessarily mean that the regulator was in doubt of the contractual position.
Fox argued that the statements given by FINMA on 23 March suggest that triggering a Viability Event on the Credit Suisse AT1s appear to have relied on the second prong scenario described from the bond prospectus above.
“The FINMA public statement acknowledges that Credit Suisse was granted extraordinary government support by way of the grant of extraordinary liquidity loans secured by a federal default guarantee on 19 March, but it is silent with respect to whether this action had the effect of improving Credit Suisse’s capital adequacy,” Fox said.
Some lawyers have raised questions over the FINMA interpretation of the covenants. Boutique law firm Pallas Partners argued that the Credit Suisse-UBS merger deal was effectively “reverse-engineered” and put together starting from the end, as reported. Pallas founder Natasha Harrison had suggested that the Swiss National Bank wanted the takeover by UBS and then sought to achieve this by upending any claims hierarchy and ignoring the no-creditor-worse-off principal, before resolving to write off the AT1s. As reported, law firm Quinn Emanuel on 21 March also announced that it had put together a multi-jurisdictional team of lawyers, who were in discussions with a number of holders of Credit Suisse’s AT1 capital instruments, representing a significant percentage of the total notional value of AT1 instruments issued by Credit Suisse, about the possible legal actions that may be available to them.
“There are issues around the point of non-viability – you need to declare bank is non-viable, but how do you justify treating the equity as having value in this case?” a second lawyer said. “Then why are laws being changed to enable this write-down when you can already do it under the bond documentation?”
Fox noted that what is clear is that disclosure contemplated a full write-down, and the Risk Factors warned investors that this eventuality would be subject to a subjective determination by FINMA and that this would be beyond Credit Suisse’s control. “Article 5(a), which appeared on a Sunday evening and expressly permits the write down of the AT1s, was a change in Swiss law that had a material adverse effect on the notes – a potentiality that was also covered in the Risk Factors,” she said.
Credit Suisse’s C/C rated EUR 1.5bn 4.5% AT1 perpetual notes are indicated at a low cash price of around just 5-mid on Markit, versus 56-mid levels at the start of 2023.
“We never bought Swiss bank AT1 as the bond prospectus says the Swiss authorities can decide on a viability event to their own discretion and with no justification required. I would argue there is insufficient information from my end to understand what they forced upon Credit Suisse,” one buysider said.
A second buysider argued that AT1s are basically like a presubscribed rights issue, and they are a write-down instrument that is subordinated to equity. He also added that in theory in the EU and the UK, an AT1 can have its coupon stopped, but the company can still pay a dividend, so it is subordinated to equity there as well. “The legal case will take years and probably go nowhere,” the second buysider said.
Unpopular bondholder precedent
AT1 bonds are notes that are issued by banks that contribute to the total level of capital that the banks are required to hold by regulators, according to a Twenty Four Asset Management market update.
AT1 financials investors have faced large losses before with the 2017 announcement that Spain’s Banco Santander would acquire beleaguered rival Banco Popular for EUR 1 imposing losses for holders of the banks AT1 securities.
The future outlook for AT1 investments looks riskier after the Credit Suisse headlines in spite of the ECB comments that recovery prospects may be different to Switzerland in other EU states.
A red flag for investors was the 24 March announcement that Deutsche Pfandbriefbank decided not to call its EUR 300m AT1 bond after evaluating various factors including market conditions and economic costs. The bonds will reset to a new fixed coupon from 28 April 2023, and the issuer will have the option to call the notes again in April 2028. German banking company Aareal Bank also earlier last month on 20 March noted that it would not exercise its call option on its EUR 300m AT1 bond issued in 2014, with the decision reflecting the bank’s strategy of evaluating all call decisions regarding securities, incorporating economic aspects alongside considerations of market conditions as well as the current and future regulatory value of the respective capital instruments.
Some investors had been considering whether the fallout from the writing off of Credit Suisse’s AT1 bonds earlier this month could provide a positive tailwind for corporate hybrid debt if buysiders rotate out of bank loss absorbing paper and into subordinated corporate issuance, given that the instrument provides greater yield than investment-grade senior paper and there is no risk of the regulator-mandated writing down of these bonds, as reported.
Corporate hybrid possible extension risks leave these securities as a long duration play. Ratings agency reclassification of equity as debt also opens downgrade potential. But the growing asset class had been an increasing focus for high yield investors in recent months, as reported.
“I think it is very difficult as an institution even if for at least for next six months to call AT1s. What options do banks have for replacing them? Two options, either issue capital or a new AT1,” a third buysider said. “If we don’t want the AT1 market to be closed until 2030, the EC had to step in and say something. Banks live on trust.”
The third buysider continued that he liked all the recent AT1 issuance over the last six months that had a long call from now. He added that they are great assets but corporate hybrids are a more tricky investment and more idiosyncratic than AT1s with the call dates very difficult to predict.
“Whether the AT1 buyer base comes back is questionable. That’s why the Bank of England and the ECB were fast to say they would always reflect the hierarchy of claims,” the first buysider said. “The regulators want to reinforce that Switzerland is the outlier.”
Credit Suisse declined to comment.