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Christopher Joye | Coolabah Capital
The big news over the weekend is that UBS has acquired 100% of Credit Suisse (CS) for CHF3 billion, representing CHF0.76 per share, imposing 89% losses on CS shareholders from their equity values 12 months ago. Crucially, CS's senior and Tier 2 bond holders did not suffer any losses at all, and depositors were 100% protected. But CS hybrid owners were subject to full write-down (ie, a 100% loss). For what it is worth, we were shorting CS bonds in 2022, and have been advising our investors to avoid them since February 2021.
So-called write-down, also known as "bail-in" (ie, where investors wear losses in insolvencies and bank failures), has been relatively common in the fragile European banking market, with many cases, including in Cyprus (2013), Austria (2014-2016), Denmark (2016), Greece (2009-2015), Netherlands (2013), Portugal (2016), Slovenia (2013), and Spain (2012 and 2017).
Write-down is normally triggered by a move by the government to bail-out the failing bank. In this instance, the Swiss government has offered a range of emergency support measures to facilitate UBS's shot-gun acquisition, including:
What is absolutely fascinating is that while CS's equity and hybrid owners bore large losses (see more below), neither CS's bail-in-able senior bonds nor its Tier 2 bonds wore any losses at all (depositors have also been protected). This is a very interesting precedent: debt has been safeguarded, but equity has been fully loss-absorbing. This is likely because this was considered a going concern event rather than a full resolution of a failed bank.
CS had 58 bail-in-able senior bonds on issue (known as "holdco bonds"), worth some EUR56.6 billion, as well as 7 different Tier 2 bonds, including a USD$2.5 billion Tier 2 bond that was Basel 3 compliant with explicit write-down clauses in the event of the Swiss government having to provide emergency support to save CS or resolve it.
These bonds could have been bailed-in, and worn losses, but the Swiss government appears to have decided only to impose losses on equity and hybrid holders. Legally, because the government has had to step-in and furnish the abovementioned support initiatives, they appear to have had no choice but to trigger the official write-down clause in CS's Additional Tier 1 (AT1) capital hybrid securities, which are classified as "going concern" capital alongside common equity (or Tier 1 capital). This is required under the terms of the CS hybrids if there has been "an irrevocable commitment of extraordinary support from the Public Sector".
In contrast to many other bank hybrids, including those issued by Aussie banks, CS bank hybrids cannot, and do not, convert into equity in this scenario (ie, Aussie bank hybrids are converted into equity before a write-off). Instead, the CS hybrids must legally go directly to write-off. They further do not permit any partial write-off: the only option is for the regulator to fully write-off these securities.
In total, CHF16 billion of AT1 hybrids were written-down: they were trading at about 25-35% of their face value over the weekend in anticipation of these losses.
We've long argued that this interest rate hiking cycle will inevitably "break things" and precipitate defaults, and we are watching this play-out amongst weaker borrowers right now;
One of the investment banks commented on what UBS will look like after this merger:
UBS confirmed its day-1 proforma CET1 will be ‘significantly above’ their 13% target. 4Q22 figures - UBS CET1: 14.5%, RWA $320bn & leverage exp: $1,029bn and for CS, CET1: 14.1%, RWA: chf251bn, leverage exp: chf651bn. Simplistically adding RWAs and CET1 plus chf15.8bn AT1 contribution roughly puts starting-point CET1 ~18.4%. So if we assume they land at 13.5% CET1 for day-1, implies ~chf26bn of purchase accounting marks, restructuring costs and acceleration of noncore runoff. Net, good outcome for broader stability and CS senior bonds...
CS's senior holdco bonds, which are bail-in-able, have the following specific terms regarding bail-in:
The Swiss Resolution Authority may fully or partially write-down the HoldCo Notes and/or convert the HoldCo Notes into equity of CSG If the Swiss Resolution Authority were to open CSG Restructuring Proceedings, it would be able to exercise its Swiss Resolution Powers to fully or partially write-down the principal of and/or accrued interest on the HoldCo Notes. In the case of a full write-down of the principal of and accrued interest on the HoldCo Notes, the HoldCo Notes would be permanently written-down to zero and cancelled, and Noteholders would lose all of the amount of their investment in the HoldCo Notes. Upon the occurrence of any such full or partial write-down, Noteholders would not, at such time or at any time thereafter, (i) receive any shares or other participation rights in CSG or be entitled to any other participation in the upside potential of any equity or debt securities issued by CSG, or (ii) be entitled to any write-up or any other compensation in the event of a potential recovery of CSG or any change in the financial condition thereof.
CS's Tier 2 bonds have similar language:
Following the occurrence of a Write-down Event, a Write-down will occur and the full principal amount of the Notes will automatically and permanently be written-down to zero on the Write-down Date
A “Write-down Event” means either a Contingency Event or a Viability Event. A “Contingency Event” will occur if CSG (or any Substitute Issuer) gives Holders a Contingency Event Notice. CSG (or any Substitute Issuer) is required to give Holders a Contingency Event Notice (within the required notice period) if the sum of (x) the CET1 Ratio contained in the relevant Financial Report and (y) the Higher Trigger Capital Ratio, is below 5.125 per cent
A “Viability Event” will occur if either: (a) the Regulator has notified CSG that it has determined that a write- down of the Notes, together with the conversion or write-down/off of holders’ claims in respect of any and all other Progressive Component Capital Instruments, Buffer Capital Instruments, Tier 1 Instruments and Tier 2 Instruments that, pursuant to their terms or by operation of law, are capable of being converted into equity or written down/off at that time is, because customary measures to improve CSG’s capital 12 adequacy are at the time inadequate or unfeasible, an essential requirement to prevent CSG from becoming insolvent, bankrupt or unable to pay a material part of its debts as they fall due, or from ceasing to carry on its business; or (b) customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible, CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving CSG’s capital adequacy and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business.
Christopher Joye is a Portfolio Manager and Chief Investment Officer at Coolabah Capital. All prices and analysis at 20 March 2023. This information was produced by Christopher Joye and published by Livewire Markets (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531). This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.