Credit Suisse AT1s: legal battle may bake in a Swiss discount

Angry investors are parking metaphorical tanks on Paradeplatz in Zurich’s financial district. Holders of $17bn in Credit Suisse AT1 bonds are squaring up for a legal fight with Switzerland. This promises to be as fierce as the scrap between Argentina and US hedge funds over a 2001 debt default.

Swiss authorities wiped out $17bn of the securities when they engineered a takeover of the struggling lender by UBS. This came as a bigger shock than the rescue deal itself.

Why? Equity is supposed to evaporate before AT1s, but Credit Suisse shareholders have been promised UBS stock worth some $3bn. Moreover, AT1 securities — designed to absorb capital losses — were entirely wiped out even though Credit Suisse was well-capitalised.

Law firms such Quinn Emanuel and Pallas are mustering disgruntled bondholders. Claims including compensation should easily exceed the value of the bonds.

The legal argument may run like this. In an insolvency, Swiss law decrees that equity absorbs losses before debt. Anyone working to stave off an insolvency is precluded from disregarding that.

Swiss AT1 bonds are bound by fine print envisaging the inversion of the hierarchy in some cases. But it is questionable whether Credit Suisse’s shotgun marriage qualified.

Switzerland hurriedly passed an emergency law empowering regulators to void the AT1s. Bondholders may still sue the authorities for an alleged failure to respect property rights.

The whole AT1 asset class has taken a knock. If AT1s are junior to equity, buyers should get coupons higher than equity returns. Credit Suisse AT1s trade at mere cents. This intrigues hedge funds with a legal bent.

The case of Switzerland vs Bondholders will be argued as hotly and lengthily as Jarndyce vs Jarndyce, a fictional probate case only benefiting lawyers. It could prove excruciating for Switzerland. It may expose exactly why officials handed UBS a $17bn sweetener at bondholders’ expense, while giving shareholders a small sop.

EU and UK regulators have reaffirmed commitment to the traditional capital hierarchy. If AT1 bonds cost issuers more than equity, no more of them will be issued and capital rules would need rejigging.

The implicit message is that Switzerland is on its own. Brussels and London are shielding their own prudential regimes. If that creates a Swiss discount for regulatory capital issued by its banks, too bad.

The Lex team is interested in hearing more from readers. Please tell us what you think about AT1s the comments section below.