The Swiss banking sector's turmoil and government intervention shake investor confidence while UBS navigates the aftermath and explores options for capital restructuring and CoCo issuance.
This past March, the Swiss Financial Market Supervisory Authority, better known as FINMA, caused a stir in financial markets internationally after the Swiss regulator forced UBS to go through with an unprecedented acquisition of the now-defunct bank Credit Suisse. Perhaps the most notable market occurrence that stemmed from this transaction was Credit Suisse’s government-facilitated default on additional tier 1 (AT1) bank debt, a type of security that banks incorporate into their capital structures to act as a liquidity buffer in the event of a financial crisis. AT1s, alternatively known as CoCos or contingent convertible bonds, are financially engineered to be converted into equity when a bank’s capitalization ratios fall below regulatory requirements. While such an occurrence would be a blow to any bank’s reputation, the Swiss government decided to execute a total write-down of the nominal value of all Credit Suisse AT1 debt, which wiped $17 billion in liabilities off Credit Suisse’s books at the expense of bondholders. This caused the AT1 debt market, worth a total of about $275 billion, to slide, with yields across all such securities spiking as investors feared that the Swiss bank’s collapse could trigger a chain reaction of defaults at other financial institutions based in Europe. However, at the time of this writing, no such event has occurred. Now that UBS is the only major international Swiss bank remaining, the firm will have to update its capital structure to account for the mass influx of new assets and liabilities now on its balance sheet. This has caused a lot of speculation among investors as to what kinds of coupon rates and yields they can expect if UBS decides to greenlight the sale of new CoCos. Just last month, on the 25th of April, Sumitomo Mitsui Financial Group (SMFG) was the first bank to underwrite new junior subordinated unsecured CoCos with perpetual maturities, totalling a little over $1 billion. The fixed income market seems to have responded warmly to the sale, with the Japan Credit Rating Agency (JCR) giving SMFG’s newest AT1 issues ratings of A-.
UBS’s AT1s have been volatile given the turmoil in the Swiss banking sector. According to Refinitiv, if UBS were to issue new CoCos, they would have to compensate investors for assuming excess risk by offering yields upwards of 12%. Such a cost may be prohibitively expensive for Switzerland’s largest bank. Regardless, that may simply be a cost UBS has to incur if they are to deploy sufficient liquidity buffers in their new capital structure.
On May 12, according to Reuters, the European Credit Derivatives Determinations Committee said it would launch an investigation as to whether a "governmental intervention credit event" occurred with respect to Credit Suisse. The committee will be tasked with determining the specifics of the subordination of Credit Suisse’s AT1s and will decide whether this credit event will trigger payment of any credit default swaps that are effectively insured against the former Swiss bank’s CoCos.
Written by: Alan Torres, CIO at Sora Capital A.C.
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