The Credit Suisse UBS deal raised a spotlight on exposure to riskier segments of the fixed income market, AT 1 bonds in particular. As part of UBS’ acquisition of its Swiss competitor, shareholders will be in line for a CHF3bn (£2.65bn) settlement while the holders of riskier Tier 1 bonds – AT1 bonds, will get no compensation. This is bad news for investors in CoCo bonds, of which there are currently more than $25bn (£20.4bn) in circulation. Credit Suisse alone had issued $17bn (£13.9bn) of the risky debt. Other major issuers are Santander and HSBC Lloyds in the UK.
Investor exposure
Investors with some of the biggest exposure to Credit Suisse AT1 bonds are Pimco, Lazard- Freres Gestion and GAM, according to a Reuters report based on Morningstar data. Lazard held about 3% of its €1.4bn (£3.6bn) of its EUR Lazard Capital FI SRI fund in Credit Suisse AT1 bonds, the firms latest fund factsheet shows. Pimco held more than half of its GIS Capital Securities fund in AT1 debt, though the fund factsheet does not specify the issuers. Fund factsheet figures date back to the end of February, which might mean that fund managers have been able to liquidate their holdings prior to the UBS acquisition. Moreover, the exact level of exposure across these funds varies by currency share class. portfolio institutional has approached the firms in question but they declined to comment.
The decision has also been a challenge for AT1 ETFs such as Wisdom Tree and Invesco, who have both launched funds offering passive exposure to CoCo bonds. Wisdom Tree’s AT1 CoCo bond ETF does not list Credit Suisse in its main holdings, but it has nevertheless dropped from 10.000 basis points to 8800 basis points since the 14th of March.
Hierarchy of claims
The Swiss decision not to compensate AT1 bond holders has sparked controversy among investors, as it contradicts the usual hierarchy of claims in an insolvency scenario, whereby creditors should be prioritised over shareholders. Some investors are now planning to take Swiss regulator Finma to court.
But holders of AT1 bonds, also called contingent convertible or coco bonds, now dubbed CoCo pops do not have similar rights to conventional bond holders.
AT1 bonds were launched in the aftermath of the global financial crisis and are bonds issued by banks aimed at minimising the risk of a government bailout if a lender runs into trouble. Unlike regular bonds, AT1 debt converts into equity if the lender’s capital levels fall below a certain threshold. In good times, it appealed because AT1 bonds for banks like Credit Suisse offered a coupon in excess of 9%.
The decision not to compensate Credit Suisse’s AT1 bond holders has sparked fears in the wider bond market. Coupons for AT1 debt for other lenders have now reached double digit figures, making it more expensive for banks to borrow on capital markets.
Meanwhile, the Bank of England has issued a statement which confirms that in the UK, AT1 bond holders will rank ahead of equity investors, in a bit to reign in a flight from bank debt.
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