While investors are taking their cases to court, the market for AT1 bonds has rebounded remarkably well following the write-down at Credit Suisse. According to fund manager Luca Evangelisti speaking to finews.asia, bonds from Swiss banks are now trading with hardly any risk premium.
The write-down on contingent convertible bonds by the former Credit Suisse (CS) is now having a global repercussion. Several hedge funds in the US are suing UBS, the new parent company of the troubled bank. These professional speculators argue that they were misled about the value of the so-called AT1 bonds.
Measure of Last Resort
This comes after hundreds of investors filed complaints with the Swiss Federal Administrative Court last summer. They accuse the Swiss Financial Market Supervisory Authority (FINMA) of acting disproportionately in the case of the nearly 16 billion francs write-down.
In March 2023, FINMA ordered the measure as a last resort to support the forced sale of CS to UBS with additional capital. So while affected AT1 investors are going to court around the world, other investors in contingent convertible bonds issued by banks, also known as CoCos, couldn't be more relaxed. «At current valuations, there is not much premium on securities issued by Swiss banks,» says Luca Evangelisti (pictured below) to finews.com.
Market has Flourished
(Bild: Jupiter AM)
The Italian manages the Financials Contingent Capital fund at British fund house Jupiter Asset Management, which specialises in precisely such securities.
The vehicle invests around 110 million dollars in AT1 bonds and other instruments that are available following the applicable regulations to stabilize large banks in the event of a crisis. The market for such instruments has flourished since the initial shock of the CS write-off and, according to Evangelisti, has made a robust start to 2024. Since January, such instruments have yielded returns of up to 3 percent.
The fund manager, who used to work for leading credit rating agency Moody's, among others, believes this could continue. «The market considers it very unlikely that we will experience an event like the emergency rescue of CS in the medium term,» he says.
Tug-of-war About to Begin
Meanwhile, Switzerland is preparing for just such a scenario with the new UBS-CS. At the beginning of April, the Federal Council, in a comprehensive evaluation (in German), pushed for more equity capital at the new megabank, unsettling the bank's leadership, including UBS President Colm Kelleher and CEO Sergio Ermotti, who categorically rejected such a proposal.
While the political tug-of-war is about to begin, bond expert Evangelisti has already done the maths. He expects that Switzerland will tighten capital requirements, especially for systemically important banks, thus potentially increasing the need to issue more AT1 bonds. «Concerning UBS, we see a clear need for new issues of such instruments,» says the finance professional.
Timely Retreat
In fact, at last week's Annual General Meeting, UBS had convertible capital of up to 70 million authorized, which the bank can use to create more scope for issuing AT1 bonds. This seems to further substantiate the fund manager's thesis.
While Evangelisti could buy into the issue of future UBS mandatory convertibles, his fund withdrew from the CS AT1 bonds on time. Fortunately, all positions were sold at the beginning of 2023. The bond specialist says that the fund had already underweighted the securities of the major Swiss bank in its portfolio beforehand. Instead, the Jupiter fund acquired senior bonds from CS, which benefited greatly thanks to the takeover by UBS, he recalls.
Prescribed Hierarchy Was Disregarded
So now, a good year after the emergency rescue of Switzerland's second-largest bank, would it be appropriate to finally get back to business as usual? Not quite, according to the fund manager. He also concedes that the Swiss authorities' approach to the AT1 write-down has frightened investors. «The prescribed hierarchy, whereby first the shareholders and only then the bondholders lose their investment, was disregarded,» says Evangelisti.
The message from March 2023 resonates. None other than the Bank for International Settlements (BIS) is currently conducting a consultation on the future of AT1 securities. The BIS is also looking into the question of whether the environment for the instruments has fundamentally changed as a result of the CS case.
Furthermore, the regulators are also asking why the mandatory converters are always triggered so late; in the case of CS and Spain's Banco Popular Español in 2017, they were only used when the banks could only be sold.
No Quick Change
However, Evangelisti does not believe that the framework of the AT1 bond business will change quickly. This would require a consensus, at least across Europe. Moreover, a potential change increase of the current trigger level of the AT1 bonds would make the instrument more risky, resulting in investors demanding much higher yields.
The latter could prove prohibitively expensive for the banks.
