UBS and Credit Suisse (CS) have merged, backed by government protection for certain potential future losses. However, CS’s Additional Tier 1 (AT1s) were written off even though shareholders will retain some value. The deal was put together at immense speed with the aim of restoring confidence in CS and more widely the European banking sector. Nonetheless, the decision to write down the AT1s to zero has seen the wider European bank AT1 market react aggressively.
The CS situation will lead to greater scrutiny and differentiation between subordinated debt (i.e., AT1 and Tier 2 (T2)) structures from different jurisdictions, particularly whether the securities are write-down only or have equity conversion features. In the case of the former, whether the securities are partial/full write-down or full write-down only, given the differentiated treatment between CS’ AT1 bondholders and shareholders, subordinated debt with equity conversion features should trade at a larger premium (or lower credit spread) compared to subordinated debt which is full write-down only.
The Australian bank AT1 and T2 structures have equity conversion language included (albeit if equity conversion doesn’t occur within five business days, they will be written down). Further, the Australian bank AT1 and T2 structures have partial/full write-down, implying the ability for some recovery (note: this was not the case with the CS AT1s).
At the time of writing and noting the lows and where they are marked now:
- European AT1s: low -30px, now -10px
- Australian AT1s (in USD): low -8px, now -4px
- Kangaroo AT1s: low -20px, now -5px
Importantly, there was no reference to CS’ Tier 2 securities in the FINMA statement. The CS Group (holdco) and CS Operating Company (opco) senior bonds remain obligations of CS Group and CS Operating Company as fully owned subsidiaries of UBS. UBS has confirmed its day-1 proforma CET1 will be ‘significantly above’ their 13% target. This is a good outcome for broader stability of the banking sector and CS T2 and senior bonds.
Markets have calmed somewhat over the past 24 hours. We would caveat this by noting that not many flows have actually traded at these levels, but they have been marked lower.
On the Kangaroo perps, the trigger is a Common Equity Tier 1 (CET1) ratio, which results either in a temporary or permanent write down.
The good news for the three banks listed above, is that they have some headroom to the CET1 trigger / Distance to Trigger. The bad news is that there are no equity conversion features attached (unlike the Australian bank AT1 and T2 structures), which is a consideration from the CS situation, where we’ve seen European authorities adopt a less bondholder friendly approach. Nonetheless, the three European banks do exhibit stable fundamentals. For example, even a weaker name like SOCGEN with perps rated Ba2 via Moody’s, is on an improving fundamental trajectory. The BNP perps are rated Ba1/BBB- (via Moody’s and S&P) and UBS perps are rated Baa3/BB (via Moody’s and S&P) respectively.
Source: CreditSights
Going forward, AT1 as an asset class will likely have to offer a higher credit spread or risk premia considering the ability to be fully written down, even when shareholders retain some value.
