CS’s AT1 bond writedown

One unexpected outcome of the Credit Suisse crisis and buyout by UBS is the impact on holders of its AT1 (additional tier 1) bonds.

AT1 bonds are the lowest tier of debt securities that can be issued. Many carry an equity conversion feature, and these are known as contingent convertible bonds, or CoCos. Technically, AT1 bondholders are senior only to shareholders in the event of a corporate failure.

However, in the case of the UBS’s buyout of Credit Suisse, shareholders will receive some compensation whereas AT1 holders will have to forfeit all their capital.

Widespread bondholder panic

This has caused a global panic among AT1 bondholders amid fears of more banking collapses. Even the Asian market has wobbled significantly with prices down around 2 – 8 points.

The steepest falls were seen among high-beta Hong Kong banks such as HSBC and Bank of East Asia. Thai banks such as Kasikornbank saw moderate falls of around 4 points, while China banks were deemed low beta given their government support, and therefore only fell by 2 – 3 points.

Large global and Asian market

The global USD-denominated AT1 market is estimated to be worth US$275 billion¹ and is deemed to be highly liquid. They are mainly issued by investment-grade European entities, based on large deals averaging US$1.3 billion each².

In Asia, the local currency AT1 market is even bigger at US$569.2 billion, of which nearly 80 percent is comprised of CNY-based China issues. Japan is another active issuer of AT1 bonds. On the other hand, USD issuances, largely by Hong Kong and China entities, total just US$42 billion.

Stay cautious on AT1 bonds

Looking forward, we expect the current pricing weakness to continue on the back of lingering weak market sentiment. While the UBS buyout has managed to calm most Asian investor nerves and prevented a deep market correction, the global banking sector volatility looks unlikely to be at an end.

It is also possible that, in the event of bank runs spreading to Asia, AT1 writedowns could extend to Asian entities. Hong Kong and Singapore are the only two jurisdictions that have both a contractual and a statutory PONV “point of non-viability” trigger framework, while the others only have a contractual framework.

In a statutory framework, if there is a non-viability event, then the shareholders of the bank are first stripped of their rights, before the capital instrument holders are written down or converted to equity, as happened with Spain's Banco Popular in 2017. In a contractual framework, if an issuer’s AT1/Tier 2 is written down or converted into equity upon a breach of a trigger or PONV, the issuer's shareholders do not lose their rights as long as the issuer's net assets are positive.

Asian banks are fundamentally sound

That said, it is our view that in terms of their fundamentals, Asian banks, and especially Singapore banks, are strongly capitalised, and have good diversified liquidity, credit buffers and conservative business models. We also see central banks being highly supportive of their financial institutions in most Asian markets.

While the probability of contagion exists, this risk is limited to second and third order effects. For example, we would expect deposit flows to increase across Asian markets, although this will likely be due to yield differences between banks, rather than stemming from bank failures.

It is also possible that some flight-to-quality will occur, with funds moving from riskier AT1 bonds to higher quality, shorter duration bonds offered by highly-rated issuers such as the Singapore government. Over in China and unlike the rest of the world, banks are dealing with rate cuts rather than rate hikes, resulting in less deposit volatility. In particular China state-owned banks look attractive given their 100 percent sovereign back-up, low beta and relatively subdued dollar funding needs in the near term.

¹Bloomberg, 20 March 2023
²Bloomberg, based on the BCCGTREU index, as of 30 September 2020. Source: Lazard Frères Gestion