Credit Suisse’s takeover causes turmoil in a $275B bond market
economist.com
economist.com
> This — a “7% trigger permanent write-down AT1” — is not the only way for an AT1 to work, though it is the way that Credit Suisse’s AT1s worked. Some AT1s have different triggers. Some AT1s convert into common stock when the trigger is hit, instead of being written down to zero; others are temporarily written down (they stop paying interest) when the trigger is hit, but can bounce back if the equity recovers. (Here is a 2013 primer on CoCos from the Bank for International Settlements.)
> These securities are, basically, a trick. To investors, they seem like bonds: They pay interest, get paid back in five years, feel pretty safe. To regulators, they seem like equity: If the bank runs into trouble, it can raise capital by zeroing the AT1s. If investors think they are bonds and regulators think they are equity, somebody is wrong. The investors are wrong.
> In particular, investors seem to think that AT1s are senior to equity, and that the common stock needs to go to zero before the AT1s suffer any losses. But this is not quite right. You can tell because the whole point of the AT1s is that they go to zero if the common equity tier 1 capital ratio falls below 7%.
> ...
> That's the trick! The trick of the AT1s — the reason that banks and regulators like them — is that they are equity, and they say they are equity, and they are totally clear and transparent about how they work, but investors assume that they are bonds. You go to investors and say “would you like to buy a bond that goes to zero before the common stock does” and the investors say “sure I’d love to buy a bond, that could never go to zero before the common stock does,” and the bank benefits from the misunderstanding.
[1] https://www.bloomberg.com/opinion/articles/2023-03-20/ubs-go...
When the banks really got in trouble, the retail AT1 investors were zeroed out, losing billions. But the story didn't end there. Cases went to trial, as investors claimed that they were deceived into buying instruments they didn't understand, by institutions that had a lot to gain by pushing them. Money was recovered in many cases, albeit many years later.
I don't know the story of who bought CS' AT1s, but it'd not be surprising if we had a bonus chapter or two, just like in the Spanish equivalent, where regulators and judges have to choose between bankers and a non-trivial number of voters that considers themselves scammed, and can change their vote accordingly.
Either way, It's not hard to see that this kind of instrument is not something that an unsophisticated retail investor should be buying, ever.
Separate problems. One, a security issued by an issuer. The second, bad sale by a broker. That the broker is affiliated with the issuer is interesting, and I imagine everyone who bought CS AT1s is gearing up the lawsuit bazooka, but not super relevant to the zeroing out per se.
In general complicating things is not a great idea. Why didn't the regulators just say "hey you guys just need to issue more regular equity" instead of inventing this weird Frankenstein?
Especially in a crisis, people need to be able to think quickly and clearly about what they have, and making things more complex does not help that.
Issuing equity in a crisis is very expensive, your share price is at a low point, your diluting the existing shareholders who have already lost a bunch of cash.
Easier to issue paper that is pretending to be equity, claiming to be senior while actually being junior to not just actual losses of capital, but to regulatory whims.
I dont want to come over as a socialist, but if your country has a bank with your national reputation riding on it, it should probably be part nationalised anyway - maybe someone could design a hybrid bond/equity/warrant/option for the state to hold with their half. If a corporation is borrowing your name and reputation you deserve to get paid for it (in non trickle down hiring and taxes $$'s).
It's something that no-one should buy and something that should not exist at all. All these complex products are made by the banks to make quick money and bonuses.
It should not be allowed plain and simple.
As we can see now, banks, investors and regulators cannot even figure out how these products work.
For starters, if they misunderstand how something works that badly, how were they modeling it to calculate value and volatility?!
"Sophisticated" financial players should be laughed out of the building for essentially saying "I didn't research what I was buying, and I just assumed they were like this other common thing."
Better a few lose their shirts, such that others maintain a healthy dose of fear to motivate due diligence.
Why didn’t they make sure they understood what they were getting into?
They were offered a contract, took it, got something (a home they probably couldn't afford), and then lost their home when rates exploded.
"Conned" seems a little strong for agreeing to a bad contract.
On the other hand, to the original point, it seems fair to expect bond traders to be more financially sophisticated than home buyers.
This kind of details can get lost in large organization when things get reported to higher ups. Which of course might be also beneficial to those doing the investments. Your risk exposure seems low, but profits are good - might earn you a good bonus.
The comment above is basically right. These are esoteric/exotic securities. If one is buying an exotic security whose value is based on the outcome of a bank going down(itself a complex process)... they need to read the docs.
That being said, I don't think most banks are deliberately trying to put risk on the naive. They mostly just assume the buyers of the securities understand the situation. Even people inside a bank don't have a crystal ball on where things are going. A sophisticated bank investor can often see the situation more clearly than someone in the bank.
Other AT1s apparently do not have such clause, but that doesn't mean investors in those bonds are entirely safe from this ever happening to them. In the EU there is BRRD, which gives regulators extensive powers to resolve failing banks pretty much however they see fit. However, EU regulators have apparently put out a statement saying (basically) that they wouldn't do it this way and would let shareholders take the hit first. It's a little surprising to me that they would tie their hands like this, but I guess a lot of EU banks are heavily reliant on AT1 funding so they felt they had to do something to restore confidence.
That write-down to zero (versus automatic conversion) was front and centre makes the Swiss precedent limited, in my opinion. Nobody who ever trades AT1s will have public opinions about it. But from what I can tell, the rules were followed.
A significant amount of that movement is being driven by Asian retail. How they were sold these is another question. AT1s without write-down may be a smart buy at the moment.
Ultimately the rules were followed, because in addition to specific capital thresholds triggering events, they can be zeroed whenever they want for any reason.
UBS got Credit Suisse for almost nothing - https://news.ycombinator.com/item?id=35236043 - March 2023 (117 comments)
Seeming to have less risk, but with limited upside, and whoops worse downside.
Also: apparently Russia quietly removed some key language about sovereignty into its bonds in 2018[2] _for some reason_.
[1]: https://a16z.com/2014/02/06/why-i-did-not-go-to-jail/ [2]: https://virginialawreview.org/articles/a-silver-lining-to-ru...
In theory, VC's, investors, and founders are considered to be "sophisticated" investors. However, they deposited a significant portion or all of their money in what was essentially a regional bank that experienced a sudden surge in deposits over the past two years. They put their money there because it offered better terms. When it went belly up they wanted to be made "whole" again. They put money in without understanding the risks.
On the other hand, as the article says, lots of these bonds were bought by Asian banks for their wealthy clients who were looking for better returns and considered these bonds safe. Who in theory sound like a similar demographic as the VCs and founders. But the comments here go on about how the investors need to lose everything.
The contrast in commentary is fascinating.
Maybe these are all just indicators that the financial market has become way too complicated with risks hidden away and no one is really able to wrap their head around all the risks. This complexity might actually be a good thing for everyone. With the central banks bailing out banks/financial instruments It is a case of reap the rewards while the going is good and then once things go bad, just shout about how the risks were not understood and get your money back.
As a side note, I am not personally invested in either of these cases.
Depositors are not investors. They don't have equity in the bank.
You're supposed to do your research on a business when you invest in it. You're not supposed to have to do research into a bank's financials when you're just using it as a bank. You're supposed to be able to trust government regulators.
It's the same way you're not supposed to have to research the construction of each bridge before you drive over it.
It’s hard to imagine how irresponsible these VCs and startups were.
If we insist that they take on their bank's solvency risk as depositors, the rational decision for most of them will simply to be move to a systemically important bank that the govt will likely never let fail (Citi, BofA..). There's no reason for them to keep their business at a small bank and take on risk they don't need to. Regional banks would then wither, and the banking industry would become even more concentrated with a few too-big-to-fail banks becoming even more powerful. It would be a bad outcome for everyone.
BTW, for anyone wondering which banks are considered to be 'systemically important', here's a convenient link to the list:
https://www.fsb.org/wp-content/uploads/P211122.pdf
And here's a link to the group that decided who goes on that list:
Those people I know who run restaurants basically have zero cash at hand and are constantly repaying some debts.
For the vast, vast majority of startups that's not their business. Storing a few million dollars should not require expert due diligence into a bank's holdings when you're in a developed country, due diligence that these business owners don't even know how to do. It's not irresponsibility, it's focusing on the things a small business should focus on rather than distractions.
How often do you assume that your prime broker will go out of business before your hedge fund does? Unless you’re a big one (Citadel, Millenium), probably “never” (it’s the same with startup companies).
Believing #3 especially makes no sense to me given the liquidity preference clauses I hear VCs have been writing into investment agreements with startups over the last few years.
These two realities, naive depositor and liquidity preferenced multi-billion dollar VCs, do not square up in my head.
FDIC protects naive depositors, not sophisticated financial professionals entrusted with billions of dollars of investment funds.
Without offering judgment: VCs are concerned with many things that can kill the companies in their portfolio across multiple different verticals. I would assume a big part of how this happened is that of all the things that could kill their returns, banks were low enough on the list that they weren't regularly thinking about it.
IMO there's a legitimate question about whether we believe it's good for one of the things VCs have to consider is bank failure risk as it will necessarily take attention away from other concerns more related to business and innovation.
If somebody deposits significantly more than FDIC in a bank account, would you advise them to research the bank's financials or not?
You would do well to be quite certain of what you're talking before you try being snarky.
And I am not setting any bar. That is the bar which has been set by the reality of things as they are. Don't complain to me if you don't like it.
You deposit money into a checking account, you don't invest money in a checking account.
The same as when you deposit a retainer with a law firm you're not an investor in the firm. Or if you have a security deposit with your apartment's management company you're not an investor in that company.
Words have definitions.
Also, practically speaking, the "consequences" for SVB depositors was likely that they would get a small haircut on their deposits, probably in the range of 0-10%. While not a great outcome, that by itself would not have been too problematic. The bigger issue was that getting access to those funds could take weeks or months, which would have been a huge issue for companies trying to make payroll.
> Maybe these are all just indicators that the financial market has become way too complicated with risks hidden away
I totally agree. And for the most part I have not seen too many folks on HN defending the SVB VC's, but more so arguing that there really is no practical reason why we can't have zero risk deposits (see discussion regarding narrow banks). And regarding the CS situation, we should also probably stop banks from selling bonds that don't really behave like bonds. At the end of the day, the vast majority of financial products can be boiled down to "get money now, pay more later" and "give money now, get more back later". And all of the complexity that gets tacked on top almost always seems to be ways of dealing/arbitraging risk. The more complexity we allow, the more likely it is someone will package and sell that risk to unsuspecting investors. We shouldn't make everyone whole when things go south, but we should absolutely correct these behaviors with regulations to prevent it from happening again.
9-11 disrupted my life pretty fierce, and then I wound up losing a job offer right after Lehman collapsed. It took an year or so after to get a "normal" consulting job (that was over a handshake only). Worse yet, I had moved abroad and coming back home was not going to happen.
In retrospect (and this absolutely was not my feeling at the time), it was a blessing in disguise. That year was much more interesting than any other part of my life, and I met a lot of people who made my life better years down the line.
I sincerely hope things go well for you.
You now if these financial markets just evaporated, who would care really, except a few aristocrats? Are they really doing anything worthwhile like building factories, or is it just a pack of percentage-harvesting parasites?
Everybody, because retirement is tied to financial markets.
We can’t possibly not pay out 401k’s, right? Isn’t that a neat trick to ensure that everybody cares about the health of financial markets?
Hopefully we are not in such calamitous times, but we shall have to see.
Where you not around 15 years ago?
When banks fail it's never "a few aristocrats" who get screwed, it's everyone.
https://www.wsj.com/articles/credit-suisse-collapse-burns-sa...
Sounds like a good deal if you can get it. Not for the AT1 bondhodlers of course.
Another way to describe it is that the write down of the AT1 bonds makes the deal possible.
From a consumer standpoint, the question is really how well the actual risk of the bonds was communicated, it sounds like the contract was executed as written.
In this case the CSFB AT1 bonds were written down to zero value and the equity holders got something.
Again, I have no opinion on if this is legal or even right. Some simply didn't expect this outcome, rightly or wrongly.
Credit Suisse’s debt-issuance documents seem to allow for stockholders coming out on top. They note that at1 bond buyers have waived any right to reimbursement in a “write-down event”. Yet the idea that stockholders may be left with something and coco holders with nothing is contrary to the understanding many buyers had about what they were purchasing: namely, a hybrid security somewhere between stocks and debt in the stack of capital.
That's a bad situation if retail investors were sold those contracts without careful explanation. Sophisticated investors can enjoy their cake.
Whether UBS made any profit on the deal or not heavily depends on how much CS's book is worth. If it's worth more than the deposits, it's a good deal for them. Given the crap that CS invested in, it may be worth much less than bank's liabilities.
Yes there is a huge appetite for fixed income products, especially when the credit quality is initially strong or at the moment when the credit is so-so but the yield is just right.
These end up in your pension, your mutual fund and so on even if you don't touch the product directly.
Granny will be shit out of luck.
In Europe we have regulations for this, and they are definitely held accountable, tho not very often.
For example in the early '00s some Italian banks were held responsible for suggesting investment in argentine bonds as "safe" to unrefined clientele.
At a minimum the Mifid questionnaire will restrict you from buying securities you do not understand, and any court will trivially be able to see if your financial advisor filled it in for you.