Sunday’s news that UBS was buying Credit Suisse immediately gave way to details of the deal. Shareholders would receive just over 3,000 million euros compared to the meager 8,000 million that the entity was worth on the stock exchange at the close of last Friday. On the other hand, holders of the entity’s riskier bonds would not see a penny after the sale. The Swiss authorities decided to shoot in the middle of the street to speed up the sale. However, this move ignored the usual priority order in these cases: first shareholders lose the investment and then bondholders. On Monday, the focus was on the damage to the latter and on the particularity of the affected securities.

Shortly after the closing of the UBS buy transaction, the news fell like a pitcher of cold water. The agreement wiped out more than 16,000 million euros in contingently convertible bonds (‘CoCos in financial parlance) from Additional Tier 1 Capital (AT1). On Monday, a significant fraction of the banks in the euro zone started the week with a sharp drop in the stock market as a result of the devaluation of their bonds in this class that they had been suffering as a result of what happened with Credit Suisse. A market that experts value at more than 275 billion euros was reeling.

What are these bonuses? These are securities issued by banks. in perpetuity that offer a return to the purchaser of the same with the consideration that, if the entity falls below a certain level of capital, these become actions (That’s why they are often called hybrid emissions). If a bank is operating normally, investors receive a coupon, like any bondholder. In the worst case, they can lead to a total loss for the investor, who would have charged the agreed interest during the time he maintained the bond. The latter occurred in Spain with the fall of Banco Popular and is the case in Switzerland.

although on paper has no expiration date, the issuer reserves the right to redeem the bond after a certain period has elapsed since its issue, normally five years in the case of Spain. These bonds were conceived as an easy way for banks to access capital in times of contingency. It is a kind of problem that arose after the turmoil of the 2008 accident banks seeking to remove risk from taxpayers and transfer it to holders. These instruments are “attractive to some investors who are looking for greater return potential, but are willing to take on greater risks”, says Sergio Ávila, an analyst at IG.

“The regulators and the banks, so starved of capital, like the ‘CoCos’, the crucial moment, the most needed. in the same amount, automatically improving the bank’s capital ratio”, they explain from the AndBank Investor Observatory.

European regulations (CRD IV) allow an additional 1.5% of capital to be added to the requirements required of each entity through this type of issuance aimed at large investors, similar to what happens in the USA and the United Kingdom. This explains why banks have resorted to them in recent years. American banks, for example, do not issue ‘CoCos’ and opt for other tools.

Among the most common conditions for these bonds to be converted into shares is that the CET1 index (common capital tier 1) of a bank falls below a certain value. For this reason, these issues are directed only to institutional investors. From BBVA they explain that “the capital ratio measures the financial health of a bank, relating the funds it has to immediately face possible unforeseen events. To demonstrate their solvency, financial institutions are obliged by the regulator to maintain a percentage of capital in relation to its risky assets”.

“The highest quality capital is made up of assets with greater capacity to absorb losses. The next level includes items that are not pure capital and, therefore, have less capacity to absorb them. For each type of capital there is a solvency index equivalent “Ordered from highest to lowest quality, we can distinguish between the following indices: Common Equity Tier 1 (CET1), Tier 1 and Total Capital. Of all these indices, the one taken as a reference to measure the solvency of banks is the CET1” , dive into the explanation.

Although the ‘CoCos’ issue brochures may contemplate liquidation if the entity is rescued, in the case of Credit Suisse the fact that shareholders will recover even a minimal part of their investment has been especially painful among bondholders. The decision will certainly lead more than one affected person to take legal action.

According to analysts at Bloomberg Intelligence, the AT1 bonds of most other banks in Europe and the UK have more protections. Only Credit Suisse AT1s included in your conditions a clause which allows them to be canceled permanently, according to credit analyst Jeroen Julius.

In any case, the operators of Goldman Sachs They are already preparing to bet on the claims that will arise around these titles. The bank’s customers received a message late on Sunday that the company would soon begin trading for the rights to these AT1 bonds. Investors looking to buy these types of bonds would be betting that they can recoup some value, potentially through litigation.

A contested measure

Experts agree that the Swiss decision will have repercussions. “That these bonds were paid in full as part of the sale transaction to UBS is controversialgiven that common equity – which is typically considered a feeder of AT1 in the capital structure – has not been completely eliminated,” says Andrew Kenningham of Capital Economics. “That’s just does not make any sense“, says Patrik Kauffmann, manager of fixed income portfolios at Aquila Asset Management, holder of bonds of this caliber. “Shareholders should receive zero” because “it is very clear that AT1s are superior to equities”, he defends.

Little by little, new ‘victims’ are known. Among the bondholders who saw their holdings disappear, two famous companies stand out: Pacific Investment Management Co. (pimp) It is investment. Both are among Credit Suisse’s largest holders of AT1 ‘CoCos’. Specifically, Pimco is the Swiss lender’s largest holder of these bonds, with about $807 million in bonds, according to Bloomberg data. On the other hand, Invesco owns about $370 million in AT1 debt from Credit Suisse.

Yes There were holders of Credit Suisse bonds who escaped (for now) of the ‘burn’. A subordinated bond issued by a Credit Suisse entity a decade ago emerged unscathed from liquidation decided upon with the purchase of UBS. The $2.5 billion note, due later this year, is a ‘CoCo’ Tier 2 note, with some features similar to the 16 billion Swiss francs of AT1 bonds pulverized. However, due to the peculiarities of the equity instruments adopted by Swiss banks after the financial crisis, the bond is accounted for as Additional Tier 2 Capital, a higher-tier type of debt that is normally only affected if the creditor ceases to be viable.

The fear that what happened to Credit Suisse’s AT1 bondholders would be repeated in other European entities set off all alarm bells in the sector: other investors could find themselves in the same situation if another bank gets into trouble. This forced the regulators of the banking sector in the European Union – the European Central Bank (ECB), the Single Resolution Board (JUR) and the European Banking Authority (EBA for its acronym in English) – to issue a joint statement in which they recall that the resolution framework implemented in the EU establishes that shareholders must first bear the potential losses of a bank in difficulty, contrary to what happened in the rescue designed for the Swiss Credit.