European Central Bank (ECB) president Christine Lagarde has said that Frankfurt “stands ready” to provide any supports required to protect financial stability as European authorities attempt to soothe investor anxieties over the wipeout of some of Credit Suisse’s bondholders after the Swiss lender was acquired by its rival UBS for €3 billion on Sunday evening.
The deal for Credit Suisse was cobbled together by Swiss regulators in recent days to stop the crisis at the bank from spreading to the rest of the Swiss financial system. Under the terms of the agreement, some 16 billion Swiss francs (€16.2 billion) of Credit Suisse’s additional tier 1 (AT1) capital bonds, which are designed to take losses when institutions run into trouble and to transfer the risk of a bank failure from taxpayers to investors, are being wiped out.
Credit Suisse said in its statement on Sunday evening that Swiss market regulator Finma had determined the bonds would “be written off to zero”.
Following the announcement, the $275 billion global market for these debt instruments, known as contingent convertible bonds, a source of funding for many banks, has seized up, with the price of risky bank debt falling across the world.
European authorities have now moved to stanch the bleeding.
Speaking in Brussels, Ms Lagarde said the ECB is “monitoring market developments closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area”.
She said: “The euro area banking sector is resilient, with strong capital and liquidity positions. In any event, the ECB’s policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed, and to preserve the smooth transmission of monetary policy.”
In a joint statement earlier on Monday morning, the ECB, the Single Resolution Board and the European Banking Authority expressed concern about the wipeout of the bondholders.
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“The European banking sector is resilient, with robust levels of capital and liquidity,” the three supervisory bodies said.
However, the statement goes on: “The resolution framework implementing in the European Union the reforms recommended by the Financial Stability Board after the great financial crisis has established, among others, the order according to which shareholders and creditors of a troubled bank should bear losses.”
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Appearing to criticise the Swiss regulatory approach, the European authorities said: “In particular, common equity instruments are the first ones to absorb losses, and only after their full use would additional tier 1 be required to be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.”
The authorities assured investors that “additional tier 1 is and will remain an important component of the capital structure of European banks”.
Additional tier 1 (AT1) bonds have their roots in the financial crisis of 2008 and its regulatory aftermath. In addition to forcing bailed-out banks to carry more capital, regulators also forced them to issue convertible bonds, so called because they have a loss absorption mechanism that is triggered if the bank’s capital falls below a particular threshold.
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When that happens, the bonds are automatically converted into equity or, as happened in Credit Suisse’s case, written down in full.
European regulators have now sought to assure holders of this type of bond that, unlike what happened at Credit Suisse, they would be given preference over shareholders in a similar situation at an EU bank.
In a research note on Monday, Goodbody Stockbrokers analyst John Cronin said that UBS is getting a lot for the €3 billion it paid for Credit Suisse “with no obligations to pay AT1 bondholders”.
“However, the monumental decision on the part of the regulator to invoke a clause in the contractual AT1 documentation to effect a permanent writedown of the AT1 securities is unprecedented and raises questions around the future role of AT1 paper in bank capital structures,” Mr Cronin wrote.
He added that the decision raises questions about what the Swiss regulator knows about the true quality of Credit Suisse’s book, a sentiment that is likely to “weigh on confidence in banks more broadly for the time being at least”.
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After tumbling in early trading on Monday, European bank stocks have pared losses despite a precipitous 60 per cent collapse in the price of Credit Suisse shares when the market opened.
Down more than 4 per cent at one point, the Euro Stoxx 600 bank sub-index was down about 1.8 per cent by mid-morning.