Banks’ riskiest bonds sink as Credit Suisse wipeout jolts market

The riskiest bonds of European lenders are plunging after holders of Credit Suisse Group AG’s contingent convertible securities suffered a historic loss as part of its takeover by UBS Group AG.

Perpetual notes issued by Deutsche Bank AG, Unicaja Banco SA, Raiffeisen Bank International and BNP Paribas SA all dropped by more than 10 points on Monday. Deutsche Bank’s £650 million ($792 million) 7.125% note dropped more than 17 pence to about 64, its biggest-ever one-day decline. Most other European lenders’ Additional Tier 1 (AT1) notes fell to record lows.

The moves follow the wipeout of 16.3 billion francs ($17.6 billion) of Credit Suisse’s riskiest bonds after UBS agreed to buy the bank in a historic, government-brokered deal aimed at containing a crisis of confidence that had started to spread across global financial markets. It’s the biggest loss yet for Europe’s AT1 market, which was created after the financial crisis to ensure losses would be borne by investors not taxpayers.

See also: Why $17 Billion in Credit Suisse ‘CoCos’ Got Erased: QuickTake

In a typical writedown scenario, shareholders are the first to take a hit before AT1 bonds face losses, as Credit Suisse also guided in a presentation to investors recently. That’s why the decision to write down the bank’s riskiest debt — rather than its shareholders — has provoked a furious response from some of the bondholders.

Credit Suisse’s AT1 burden sharing means a “broader credit risk repricing need,” said Elisa Belgacem, a senior credit strategist at Generali Investments, in a research note. “Even though banks are better capitalised than in 2008, especially in Europe, the flights of deposits from smaller banks to big and safer ones is likely to go on.”

European regulators reiterated on Monday that equities should take losses before any bonds. And, according to analysts at Bloomberg Intelligence, AT1 bonds at most other banks in Europe and the UK have more protections. Only the AT1s of Credit Suisse and UBS have language in their terms that allows for a permanent write-down, senior credit analyst Jeroen Julius said.

Still, the statement from European regulators failed to lift lenders’ AT1s from their slump, with nerves on edge about the future of the $275 billion market for bank funding.

One UK bank CEO speaking earlier, who asked not to be named because the situation is sensitive, said the Swiss regulator’s decision to wipe out the notes may have effectively killed it off.

“This just makes no sense,” said Patrik Kauffmann, a fixed-income portfolio manager at Aquila Asset Management, who holds Credit Suisse CoCos. “Shareholders should get zero” because “it’s crystal clear that AT1s are senior to stocks.”

Meanwhile, default swaps insuring UBS Group AG’s debt spiked this morning. The Swiss lender’s one-year CDS jumped 50 basis points to 148 basis points, according to pricing source CMAI as of 10:30am London time.

Risky bank bonds also tumbled in Asia, with some posting record declines. The retreat was most pronounced in bonds designed to be among the first to face writedowns if an institution gets into trouble. Bank of East Asia Ltd.’s 5.825% perpetual dollar note slumped 9.4 cents on the dollar to about 80 cents, data compiled by Bloomberg show. 

HSBC’s $2 billion additional tier 1 bond fell much as 10 cents to around 85 cents on the dollar Monday, according to credit traders. That drop would be its biggest daily drop since it began trading earlier this month.

“It doesn’t necessarily mute contagion risk,” Shane Oliver, AMP’s head of investment strategy and chief economist, told Bloomberg Television. “Funding costs for banks, whether it’s capital or debt, in Europe will go up.”

The situation at Credit Suisse could lead to many investors wanting to cut exposure to the banking sector “and if they can’t sell the weaker names, the next step will be to sell the next weakest that still has liquidity,” said Pauline Chrystal, a portfolio manager at Kapstream Capital in Sydney. “Riskier securities will tend to sell off more, so either lower rated issuers or down the capital stack.”