In the aftermath of the shocking reversal of the sacrosanct liquidation waterfall priority…
… in which Credit Suisse shareholders received CHF3 billion in value even as the bank’s entire Contingent Convertible (Additional Tier 1) junior creditor class was wiped out…
… European’s regulators rushed to calm furious investors – who suddenly dreaded their exposure to AT1 bonds at every European bank, which at last count accounted for some $275BN in securities – and assured them that Credit Suisse was a unique case and that it wouldn’t repeat elsewhere if and when more liquidations and bailins had to kick in.
They failed.
One day after Europe’s panicked response where one official after another lied through their teeth that equity will never again survive a full AT1 wipe out…
*LAGARDE: PECKING ORDER FOR ANY WRITE-DOWNS IN EUROPE VERY CLEAR
But not in Switzerland
— zerohedge (@zerohedge) March 20, 2023
… over the past 24 hours we have seen wholesale dumping of AT1 debt whose cost has essentially doubled overnight, a problem for European banks that use the notes as a crucial capital buffer.
As shown in the chart below, yields on a Bloomberg index of AT1s in Europe surged following Credit Suisse Group AG’s controversial wipeout of the risky debt, to an average of 15.4%, although they since eased slightly. In early February, yields on AT1s were as low as 7.8%, according to a multi-currency index compiled by Bloomberg. In fact, as of last night, the yield on the AT1 index surpassed the worst of the covid crunch, when yields briefly topped 15% and then tumbled after the coordinated central bank bailout of the world.
“This is a big tightening in financial conditions,” Gordon Shannon, a fund manager at TwentyFour Asset Management, told Bloomberg. “Bank funding is more expensive now and banks will lend less. This is like several rate hikes in one day and there is potential for this to play out across the rest of the market.”
The historic collapse in AT1 notes is a headache for banks, which hold this type of bond as a way to bolster financial resources that’s usually cheaper than normal equity such as shares. They were created by European regulators after the financial crisis as a way to impose losses on creditors when banks start to fail without resorting to taxpayer money.
According to Bloomberg calculations, there’s is now more than $258 billion of this type of debt outstanding in Europe, excluding the $17 billion written off by Credit Suisse. Of this, more than $20 billion of notes have first call dates this year, which means they may repriced to a much higher yield in coming months.
As those dates loom, banks will need to decide whether to issue new AT1 debt at the higher yields, or find another way to raise capital. One possibility, according to Goldman Sachs, is to replace AT1 capital with CET1 capital — or common shares — though this has traditionally been more expensive; at that point the bank may as well sell common stock.
While at some point yields will drop, in the immediate term JPM warned that the need to refinance AT1 debt could become a problem for the wholesale funding costs of European banks.
“While most banks were paying 8-10% coupon cost in recent issuance of AT1, we expect that credit investors are now likely to demand a higher risk premium across the spectrum, with the cost of AT1 issuance potentially rising into double digits,” JPMorgan analysts led by Kian Abouhossein wrote in a note. The cost of equity in the sector will also rise well into double digits, they said.
And in yet another typical European clusterfuck, at the same time the continent’s regulations about banks’ capital buffers which were established after the financial crisis, means they may have little alternative but to keep issuing junior debt and accept the higher costs that come with it.
“AT1s still have a role to play in the capital structure,” said Julien de Saussure, a fund manager at Edmond de Rothschild Asset Management. “Regulators could look at this and think they have not played their role right and change the triggers or look to grandfather the format and move to something else — but I think that is wishful thinking.”
There was a silver lining: after Monday’s historical wipeout, AT1 bonds posted modest advances in Europe and Asia after panic subsided, and investors heeded regulators’ assurances that the wipeout in Credit Suisse’s Additional Tier 1 notes wouldn’t happen in their jurisdictions under similar circumstances.
Commerzbank AG, Deutsche Bank AG and Intesa Sanpaolo SpA led the gain in AT1s, following a recovery in Asia, where bonds including those from Westpac Banking Corp. were quoted higher. The notes have only recovered some of their losses. Credit risk across both regions also fell, with indexes tracking credit default swaps linked to high-yield and investment-grade bonds in Europe erasing most of their widening since Credit Suisse roiled global markets.
“The fact that central banks and regulators in euro zone and UK came out and said ‘this is a Swiss decision and this is not the way in Europe,’ — this commitment on the AT1 asset class was important, it came quickly and it was good news,” said Erick Muller, head of product and investment strategy at Muzinich & Co. in London.
Alas, regulators and central bankers have a habit of lying “when it gets serious” and it has rarely been as serious as it is right now. So those skeptical to allocate cash to an asset that is here today but may be gone tomorrow may be wise to wait and see how the AT1 tranches is treated in the next European bank failure. Luckily, with the ECB hiking 50bps last week and set to hike even more next, they won’t have long to wait.
Tyler Durden
Tue, 03/21/2023 – 12:40
