UBS buys Credit Suisse in CHF3 billion deal, bonds fully protected as AT1s are zeroed (Updated)

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. To read more about what this means for Aussie bank hybrids, check out Jason Lindeman's analysis here.

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:

• Providing UBS with a loss guarantee of up to CHF9 billion on specific CS exposures, but only after UBS has borne the first CHF5 billion of losses,  
• Providing UBS/CS with a CHF100 billion loan as additional liquidity while the two institutions are integrating (final settlement is due in late 2023), and
• Changing the laws to waive shareholder resolutions to in turn enable a rapid-fire acquistion to be agreed over the weekend.

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.

What are the key take-aways for investors? A few come to mind:

• 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;
• Globally, bank regulators are only going to ferociously increase the intensity of capital, liquidity and general risk management requirements, which is positive for bank depositors and bond holders, but negative for bank shareholders at the margin;
• There has been a massive difference in the treatment of Tier 1 going concern regulatory capital securities (equity and hybrids) compared to gone concern bail-in-able bonds (ie, senior bonds and Tier 2 bonds), which arguably sets a precedent for systematically important banks (CS was classified as systematically important). This is because CS was still a going concern, albeit a bank that was on the brink, and had not fully failed, in which case it would have been wound-up; 
• Expectations for rate hikes may be pared back further if bank funding costs rise sharply, and this morning global central banks have announced a coordinated step-up in their liquidity operations for their respective banking systems; and
  
• There is likely to be more decompression and discrimination between ultra-high-grade banks and more vulnerable institutions in equity and debt markets. The Aussie banks are stand-outs here, with amongst the strongest capital and liquidity metrics globally.

More detail on what UBS looks like post merger

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...

Technical appendix

EU regulators have come out and stated they would never allow AT1 hybrids to be bailed-in before all bank equity is wiped out:

The Single Resolution Board, the European Banking Authority and ECB Banking Supervision welcome the comprehensive set of actions taken yesterday by the Swiss authorities in order to ensure financial stability. The European banking sector is resilient, with robust levels of capital and liquidity.
The resolution framework implementing in the European Union the reforms recommended by the Financial Stability Board after the Great Financial Crisis has established, among others, the order according to which shareholders and creditors of a troubled bank should bear losses.
In particular, common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.
Additional Tier 1 is and will remain an important component of the capital structure of European banks.

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.