As part of the rescue package for Credit Suisse as directed by Switzerland’s central bank, the Swiss National Bank (SNB), and the Swiss Financial Market Authority (Finma), all of Credit Suisse’s additional tier 1 (AT1) capital of CHF16 billion ($23 billion) will be written down completely.
The three local and Asia-Pacific banks generally hold minimal amounts of Credit Suisse’s AT1. This is because, based on Basel III rules, banks’ cross-holding of other banks’ capital instruments will lead to a direct deduction of the same type of holding of the capital instrument.
In a statement, a UOB spokesperson says: “UOB has no exposure to Credit Suisse bonds. UOB bond holdings consist of high-quality liquid assets held primarily for regulatory requirements.” Meanwhile, a spokesperson for DBS says: “DBS’s exposure to Credit Suisse’s AT1 bonds is insignificant.” Similarly, an OCBC spokesperson says OCBC’s exposure is also insignificant.
In Asia, most AT1 are perpetual securities with permanent write-down features. In China, the AT1s are in preference share format, which can convert to equity. Credit Suisse appears to have issued mainly permanent writedown AT1s.
The Monetary Authority of Singapore (MAS) says AT1 bonds in Singapore are offered in the wholesale market, which is only for institutional and accredited investors. “Financial Institutions (FI) that offer or distribute AT1 bonds are expected to make accurate and clear disclosures of key product features and risks to investors.”
Separately, the Swiss regulator’s action is causing investors and banks to wonder what Asian regulators are likely to impose in the unlikely event of a bank approaching a point of non-viability (PoNV).
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On March 20, the EU and UK authorities highlighted that common equity is junior to AT1 instruments in the creditor hierarchy in their jurisdictions. Similarly, in Singapore, MAS says: “in exercising its powers to resolve an FI, it intends to abide by the hierarchy of claims in liquidation. This means that equity holders will absorb losses before holders of AT1 and Tier 2 capital instruments.” The Hong Kong Monetary Authority has taken a similar position of equity being junior to AT1.
On March 19, a Credit Suisse press release said: “On Sunday (March 19), Credit Suisse has been informed by Finma that Finma has determined that Credit Suisse’s Additional Tier 1 Capital (deriving from the issuance of Tier 1 Capital Notes) in the aggregate nominal amount of approximately CHF16 billion will be written off to zero.”
Credit Suisse and UBS entered into a merger agreement on March 19 following the intervention of the Swiss Federal Department of Finance, SNB and Finma. UBS will be the surviving entity upon the closing of the merger transaction. Under the terms of the merger agreement, all shareholders of Credit Suisse will receive one share in UBS for 22.48 shares in Credit Suisse.
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“Pursuant to the emergency ordinance which is being issued by the Swiss Federal Council, the merger can be implemented without the approval of the shareholders,” the statement adds.
Finma surprised the market
Bail-in regulation is a key part of Basel III, implemented following the Global Financial Crisis. It requires major banks to maintain sufficient “bail-in capital” to absorb losses in the event of the unthinkable.
Under the internationally agreed Total Loss-Absorbing Capacity (TLAC) framework of the Financial Stability Board (FSB), advanced economy G-SIBs (globally systemically important banks, which Credit Suisse was) have to maintain a minimum amount of loss-absorbing capital from January 1, 2019.
Banks have different types of “graded” capital. High-quality common equity tier 1 (CET1) capital comprises paid-up capital (shares) and retained earnings, the best form of capital. These can absorb losses, and banks are required to hold a minimum CET1 all the time (see table 2). AT1 and certain tier 2 instruments are required to be loss-absorbing.
Under Basel III, these capital instruments must be able to fully absorb losses at the PoNV before taxpayers are exposed to loss. The trigger or PoNV can also include CET1 falling below a certain level of 5% to 7.5%. The PoNV condition requires all AT1 and Tier 2 instruments to be capable of being converted into common equity or written off.
The trigger for the conversion or writeoff is the earlier of (i) a decision of the relevant authority that the conversion/write-off is necessary, given that the bank is assessed to be non-viable; and (ii) a decision to inject public funds to prevent the bank’s failure.
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In Credit Suisse’s case, Finma has determined the write-off. Note, though, that when these instruments, such as perpetual securities and perpetual contingent convertible (coco) bonds, are issued, they are issued as loss-absorbing. Credit Suisse’s circular stated as much on the cover pages of its AT1 circulars.
Some market watchers were surprised by the Finma directive, as the previous occasion when AT1 was written off was when Banco Santander acquired Banco Popular in 2018. Here, both Banco Popular’s equity and AT1 were wiped out. Separately, in India in 2020, Yes Bank’s AT1 and CET1 were written down. According to JP Morgan, holders of Yes Bank’s AT1 are litigating. Credit Suisse is the first case where all the AT1 was written down, but CET1 is intact.
“We admit this development has come as a surprise. We expected a more balanced outcome with Swiss financial sector stability preserved with the continuation of at least the domestic franchise of Credit Suisse, a possible strategic sell-off of the asset management and wealth management businesses and the run-down of its higher-risk investment bank. We further expected the “no creditor worse off” principle that equity holders would bear the brunt of write-downs first in any resolution type scenario, and Credit Suisse’s current capital position provided a buffer against an adverse scenario,” says OCBC Credit Research.
Restructuring plan
Under the Swiss Banking Act, Finma has the authority to approve a restructuring plan of a systemically important bank without consulting creditors (and shareholders) beforehand to protect financial stability so that they cannot block the restructuring plan in the context of the “no creditor worse off” principle.
“Shareholders and creditors can appeal against the restructuring plan with the Swiss Federal Administrative Tribunal with the outcome being compensation rather than a delay in the restructuring plan,” OCBC Credit Research adds.
In June 2019, Credit Suisse issued $750 million of five-year contingent write-down capital notes in Singapore. Based on the announcement, 91% went to local investors, 7% to the rest of Asia, and 2% to Europeans. By investor type, private banks were allocated 84%, fund managers 10%, banks 4% and insurers 2%.
What happens when there is no AT1?
The Credit Suisse saga is likely to put pressure on AT1 issuances. “In our view, an increased focus on downside risk could increase banks’ cost of capital and make new AT1 issuance more difficult and expensive. Jittery investors will take time to revise their perceptions of risk for individual banks and instrument structures,” says an S&P Analytics report.
“As a credit product, the upside for AT1 is limited. But if AT1 can be functionally subordinated to common equity, it should offer greater returns to compensate for the asymmetric upside and downside risks. If an issuer finds it cheaper to simply meet the Tier 1 capital requirement with common equity, the motivation for issuing AT1 disappears. AT1 is premised on being a more cost-effective way of meeting capital requirements,” says JP Morgan.
JP Morgan also points out that when the AT1 market dries up for refinancing and new issuances, APAC banks can use CET1 capital to satisfy the Tier 1 ratio requirement.
Asian banks, in a nutshell Most Southeast Asia banks’ CET1 ratios are materially higher than minimum Tier 1 ratios (Indonesia at 12.9 percentage points (ppt), Malaysia at 6.4 ppt, Thailand at 6.3 ppt, India at 6.1 ppt, Singapore at 4 ppt, and the Philippines at 3.1 ppt), thus mitigating the risk of rising funding cost for AT1 capital, adds JP Morgan.
For North Asia banks and Australia, except Hong Kong (6.5 ppt), the buffer is thinner (Australia –0.3 ppt, China 0.7 ppt, Korea 0.7 ppt, Taiwan 1 ppt, and Japan 2.8 ppt). “It is worth noting that AT1 in China, Taiwan and Australia are predominantly issued to local investors,” JP Morgan says.
In Europe and Singapore, AT1 is not issued to retail investors. “Among banks in our coverage are Citic Bank, China Everbright Bank, and Huaxia Bank. Ping An Bank, Bank of Hangzhou, Fubon Bank, Cathay Bank, Mega Bank (Taiwan), CTBC Bank (Taiwan), First Bank (Taiwan), State Bank of India, MUFG, Commonwealth Bank of Australia, National Australia Bank, and Westpac Bank Corp would be likely to see a shortfall in Tier 1 ratios if they needed to use common equities to fill the gap. However, the shortfall is within 1 ppt, so even if they must issue additional common equities or step up coupon rates for AT1 materially to attract investors, the impact could be limited,” JP Morgan says.
If banks decide to hold more CET1 if AT1 becomes more expensive, they will set aside more retained earnings, curbing dividends and perhaps crimping lending to entities with higher risk weights.
What about Singapore?
MAS says Credit Suisse’s customers here will continue to have full access to their accounts. The bank’s contracts with counterparties will remain in force. The takeover is not expected to impact the stability of the republic’s banking system. Credit Suisse’s other entities here — Credit Suisse Securities (Singapore) and Credit Suisse Trust — will continue to operate under their respective licenses.
An MAS spokesperson says Credit Suisse’s Singapore branch had total balances of $38 billion as at Feb 28, representing 1.6% of the total assets of the city-state’s banking sector. In a statement, MAS says it “will remain in close contact with Finma, Credit Suisse and UBS as the takeover is executed to facilitate an orderly transition, including addressing any impact on employment.”
It adds that MAS will continue to monitor the domestic financial system and international developments closely and “stand ready to provide liquidity through its suite of facilities to ensure that Singapore’s financial system remains stable and financial markets continue to function in an orderly manner.
