The Credit Suisse bailout has rocked the European banking chess board. In the heart of the old continent, although outside the jurisdiction of the ECB, the sale of a Swiss symbol to the bank UBS was formalized last week. An operation that scrambled the usual order of precedence: shareholders got back part of their investment, while holders of the coconuts (short for Convertible Contingent Bond) lost everything. In practice, it makes these bonds more expensive for banks, which strengthen the capital buffer in times of crisis because their holders are now demanding higher yields. In other words, companies are paying more for their financing and there is a risk of even more restrictions on lending to customers.
Credit Suisse convertible bondholders, known as AT1s, lost $17 billion, which was written off in full. However, the shareholders went to the 3,000 million exchange. An amount, yes, a far cry from the 7,500 million at which the company was valued before the operation. “Switzerland has crossed a red line, the immediate consequence of which was the nervousness of debtors,” explains Joaquín Maudos, deputy director of the IVIE and professor at the University of Valencia. In fact, the markets have greatly increased the required rate of return, almost doubling in some cases. “Bank financing is now more expensive and banks will lend less,” Gordon Shannon, fund manager at TwentyFour Asset Management, told Bloomberg.
To avoid a major catastrophe and stop the bleeding, the ECB on Monday attempted to stop this vicious cycle, issuing a statement warning that in the event of a crisis, losses in Europe would be borne first by shareholders and creditors and only later by the holders of these bonds. “The EBA [Autoridad Bancaria Europea]the ECB as supervisory authority and the SRB [Junta Única de Resolución] They were specific to the order of priorities applied in Europe,” these institutions stressed in a joint statement. In other words, it guarantees that your investment will take precedence.
The announcement calmed the markets, both on the stock market and on the negotiation calls for coconuts, which stopped falling. Although nervousness had already penetrated a market worth more than 250,000 million euros (in Spain, listed banks have more than 20,000 million). “If it is not possible to fully restore confidence in the observance of the rules of the game in the order in which losses are taken over, the financing costs borne by the banks will become more expensive. And logically they will pass that on to their customers,” says Maudos Graben.
Any convertible bonds are a hybrid issue: they have debt (they pay interest to the investor) and equity (can be used to absorb losses). If a number of requirements are met, the emissions known as AT1 can be calculated as additional capital. They also do not have a specific maturity but are perpetual, with the companies reserving the right to redeem the bond after a specified period of time since its inception (usually five years).
“They were created in the previous crisis to strengthen bank capital because it is practically comparable to the highest quality and can be converted if it falls below a certain level,” says Ángel Berges, Vice President of International Financial Analysts (AFI) . Regulators require these internal bailouts so that they can be released for losses in times of insolvency. Of course, before that, the previous steps must be carried out: the highest quality capital, the CET1 fully loaded, plus the reserves generated by the profits of previous years. Then the coconuts would be drawn and then the subordinate bonds. The idea, after all, is that taxpayers aren’t the first to pay the whistler.
The precedent of the popular
It is also attractive to banks as it allows them to convert them into shares or even depreciate them if the company gets into trouble. There is a paradigmatic case used as an example in European organizations: the dissolution of Banco Popular, which was acquired by Santander for one euro in 2017. Then everyone saw their money disappear: shareholders and debtors (both the convertible contingent and the subordinated). On this occasion investors received nothing in return and taxpayer protection and financial stability prevailed.
“A greater than expected risk has emerged in coconuts. This makes financing more expensive: investors will demand more profitability from the banks for this risk and will therefore grant more expensive loans,” says Leopoldo Torralba, economist at Arcano Economic Research. In this context, future maturities will require financial groups to decide whether to issue new AT1 debt at a higher cost or to look for other ways to raise capital, which is difficult in an uncertain context like the current one.
According to JPMorgan, the need to refinance convertible bonds could pose a problem in the near term. An idea Standard & Poor’s has in abundance: “AT1 investors run the risk of suffering large losses as part of any bailout, be it as part of a formal resolution or a market solution to bail out a troubled bank.” Headwinds for a financial sector still fearing a return of stock market panic.
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