Swiss CoCo shakeout may yet help bank regulators
LONDON, March 22 (Reuters Breakingviews) - Switzerland’s forced merger of Credit Suisse (CSGN.S) with UBS (UBSG.S) has caused a real stink. The $250 billion market for contingent convertible bonds is reeling after the stricken Swiss lender was obliged to wipe out its own ones. Yet if the ensuing higher cost of issuing these “CoCo” securities means banks roll over their maturing debt rather than replace it, bank supervisors may still get a silver lining.
European regulators on Monday mobilised to calm debt investors after Swiss authorities chose to write off 16 billion Swiss francs of Credit Suisse’s Additional Tier 1 CoCos. While these instruments are explicitly supposed to take losses in a solvency crisis, Switzerland left value on the table for shareholders who rank below junior debt. Additional Tier 1 prices were on Monday down 14% from March 13 levels, according to an ICE Bank of America index, as holders feared other banks might trigger their own CoCos more readily.
Both the Bank of England and European regulators pledged on Monday to respect the bank rescue hierarchy that says shareholders should lose money before debt. But the uncertainty means investors may now demand a premium for such lower-ranking bonds. That would put banks in a fix: the securities are perpetual, meaning they have no maturity date so as to be more like equity. But they typically have an optional redemption or "call" after five years, which bondholders expect banks to honour.
That convention can lead a weak bank to call a bond to avoid angering creditors and sparking a panic, despite needing to issue at a higher rate. A case in point: only last year the already creaking Credit Suisse chose to redeem a bond. From a regulatory perspective, the presumption that a bond will be called makes it less useful as a source of permanent capital.
Some banks, like Banco Santander (SAN.MC), have chosen not to redeem bonds when it’s not in their interest. That may become more common if yields stay high or rise much higher. On average, CoCos yield just under 10% on Tuesday, according to the ICE Bank of America index, up almost a percentage point since the start of March. That’s in line with lenders’ cost of equity, despite bonds typically ranking senior to shares.
Some 19 bonds are due to be called this year, according to CreditSights, including ones issued by UniCredit (CRDI.MI), Santander, BBVA (BBVA.MC) or Barclays (BARC.L). The Italian bank’s 6.625% CoCo with a call in June was trading at 95% of its par value on Tuesday, down from around 99.5% on March 9, according to Refinitiv data. If markets stay volatile, more banks may decide to flout bond market convention. For regulators, that would be a side benefit of a destabilising week.
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Prices of contingent capital securities, a kind of junior ranking loss-absorbing bank debt, fell after bonds issued by Credit Suisse were wiped out following its takeover by UBS.
An ICE Bank of America index tracking contingent convertible bonds fell as much as 14% since mid-March, as fears over Credit Suisse’s health escalated, according to Refinitiv data. That index yielded some 9.6% as of March 21.
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