By Geoffrey Smith
Investing.com -- European bank stocks and bonds opened sharply lower on Monday after Swiss regulators' handling of the Credit Suisse collapse wrong-footed investors and cast doubt over a large part of the market for bank bonds.
Swiss financial regulator Finma decreed on Sunday that some $17 billion in Additional Tier 1 bonds issued by Credit Suisse Group (SIX:CSGN) be written off entirely as part of a deal to sell the stricken bank to local rival UBS (SIX:UBSG). That's despite the fact that shareholders will still receive some compensation for their stock.
The move triggered a sharp selloff in the $200B AT1 market in Europe on Monday, as investors dumped bonds issued by other banks. While low liquidity made it hard to quantify the losses, traders said prices were marked down by as much as 20c on the euro or dollar.
There were also sharp moves in bank equity, with UBS, the ultimate buyer of Credit Suisse, one of the worst affected, down 13.7% by 04:30 ET (08:30 GMT).
Typically, shareholders are the first to lose their money in any bank failure, with creditors and depositors only taking losses after the equity is written down to zero. However, the terms of the bonds issued by CS had expressly stated that they were junior to equity, a point that appears to have been overlooked by at least some holders of that debt.
"The problem now is how to calculate risk," one European bond trader told Investing.com.
"Before yesterday we knew that AT1 risk was based on PONV and CET1 levels," he said, referring to the commonly-held belief that regulators would only impose losses on AT1 bondholders if a bank's capital level (Common Equity Tier 1, or CET1) fell to what regulators call the "Point of Non-Viability". Finma had, by contrast, used the leeway in CS's AT1 term sheets to order the bail in at an earlier point.
The handling of the CS case means that AT1 bonds are now more exposed to broader economic risks - "And economic risks are really hard to understand and price," the trader said.
"This move is definitely unexpected," Gildas Surry, a partner with Axion Alternative Investments, told Bloomberg TV. "There is an issue of confidence and there is an issue of trust with the regulators."
AT1 bonds aren't generally held by retail investors, but they are popular with high-net-worth individuals and specialized institutional funds, who are attracted to their higher yields. Banks across Europe have issued them as a matter of course over the last decade to bolster their levels of loss-absorbing capital without expanding their share count and diluting earnings. A sharp drop in AT1 prices raises the overall cost of capital for banks, however.
Two other big issuers of AT1 bonds, ING (AS:INGA) and Deutsche Bank (ETR:DBKGn), saw their stock fall by 6.6% and 6.2% respectively, while Barclays (LON:BARC) stock was down 5.5% and Societe Generale (EPA:SOGN) stock was down 4.4%.