Some of Credit Suisse Group AG’s bond holders are furious with the terms of UBS Group AG’s takeover. The deal will trigger a complete write-down of Credit Suisse’s 16 billion Swiss francs ($17.3 billion) worth of Additional Tier 1 bonds, as the riskiest notes introduced after the global financial crisis are known. This would mark the biggest loss yet for Europe’s $275 billion AT1 funding market. At the same time, the bank’s stock holders will still get something back — they are set to receive 3 billion francs in an all-share merger.
This arrangement is controversial in that it violates the standard corporate finance pecking order. In a textbook write-down scenario, shareholders are the first to take a hit before AT1 bonds face losses, as Credit Suisse also noted in a recent presentation to investors. To make matters worse, some traders were buying these notes over the weekend. They had hoped for a benign takeover and some quick profits.
So it is no surprise that on an analyst call shortly after the deal was struck, the first question asked was about the AT1 wipeout. UBS Chief Executive Officer Ralph Hamers responded that it was a decision made by the Swiss Financial Market Supervisory Authority, not by his bank. While a loss of this magnitude can ignite strong emotions, it is also a fine reminder to traders not to bring textbooks to the real world.
Think about it from the Swiss perspective. AT1 bonds are designed as high-yield instruments with a hidden hand grenade. They serve to absorb shocks when banks start to fail. As such, their holders have contractually agreed to a complete write-off if somehow Credit Suisse triggered a “viability event,” such as “extraordinary support from the Public Sector,” or the regulators’ decision that it does not have enough capital buffer.
What to do with the bank’s equity, on the other hand, is not as clear-cut. This takeover deal was fast-tracked without the blessing of shareholders on either side. Regulators might have just given Credit Suisse’s equity owners some sweeteners so they don’t go to court and overturn the merger.
The fact that the buyout price reportedly changed from at most $1 billion to the final $3.3 billion was perhaps a sign that there were behind-the-scene negotiations with Credit Suisse’s biggest shareholders. Even at the current price, Saudi National Bank, a top investor, would be losing 1.1 billion francs less than 15 weeks from when it finished buying its stake. In other words, in the real world, deal dynamics matter more.
Meanwhile, it is quite common for companies that have defaulted on their borrowings to still retain some equity value. This is a phenomenon Asia’s high-yield investors are familiar with. Consider China’s real estate developers. Despite negating on their debt obligations, quite a few, such as Powerlong Real Estate Holdings Ltd. and Kaisa Group Holdings Ltd., are still trading their shares in Hong Kong. At $744 million and $335 million in market cap, respectively, their equity value is not entirely worthless. Last December, Cifi Holdings Group Co. even managed to raise HK$958 million ($122 million) in a new shares sale.
So unless we are in a bankruptcy proceeding, seniority does not matter. And fortunately for Credit Suisse’s 50,000-strong employees, the bank is merely folded into its larger rival; it is not entering liquidation. So sorry, Credit Suisse’s AT1 bond traders, life is unfair. Better luck next time.