UBS keeps torturing Credit Suisse bondholders

The government-brokered takeover of Credit Suisse announced in March has become cause for celebration, not regret, for rescuer UBS Group AG. But not everyone is partying.

The more it looks fortuitous for UBS, the greater the anguish of those Credit Suisse bondholders whose 16 billion Swiss francs ($18 billion) of “additional tier 1” notes were torched by regulators. Was it really necessary to sacrifice them so Credit Suisse could be transferred to a new owner with less debt?

The answer at the time was that the acquisition was risky, so UBS needed that extra capital to take hits in case Credit Suisse’s assets turned out to be worse than feared. This wasn’t the only cushion, though. The Swiss government put up insurance against 9 billion francs of losses too.

But earlier this month, UBS canceled that taxpayer-backed cover. No longer necessary, it was proving costly financially and politically. UBS shares, already doing well, are up 6 percent since then and have outperformed almost all major peers since the US banking crisis. The market seems to agree that buying a historic rival for a mere 3 billion francs wasn’t so risky after all.

Does that enable the AT1 crowd to get some relief? It’s not just that the financial justification for writing down those bonds appears to have weakened. In the aftermath of the rescue, the Swiss government said the move had ensured that “private measures” were taken in addition to “state measures.” With taxpayers off the hook, this political justification for whacking the bondholders has withered too (although big banks arguably are always implicitly underwritten by their host nation).

Knowing what we know now, the deal may still have made sense for UBS with a partial rather than complete AT1 writedown — or perhaps none at all. That’s all the more galling as even Credit Suisse’s shareholders got paid in the takeover, disrespecting the convention that they should be hit before creditors. (Senior debtholders dodged the bullet as well.)

The snag for the AT1 holders is that they’re never going to curry public sympathy. Their only leverage is litigation. The legal arguments matter more than the moral outrage and UBS’s decision to terminate government support doesn’t appear to be a game changer here. For starters, the authorities have never denied that Credit Suisse was well capitalised during the crisis, and first-quarter results confirmed that.

Swiss financial watchdog Finma provided two distinct justifications for the writedown. Aggrieved bondholders will therefore need to establish that both were unlawful.

The first is a condition in the bond contract. This states that Credit Suisse must have received extraordinary public support that had “the effect of improving [its] capital adequacy” and prevented it from going bust.

Credit Suisse indeed enjoyed Swiss support in the form of emergency liquidity. Since this was loans and not an equity injection, the AT1 holders can argue it didn’t tick the box of effectively boosting capital strength. Finma could in turn contend that Credit Suisse was facing a bank run and the liquidity spared it from selling assets at a loss to meet deposit outflows. Preventing a loss is a de facto capital boost.

Economists will be lining up as expert witnesses to argue the point. But UBS’s recent moves don’t obviously help bondholders in this technical
argument over whether liquidity improved capital adequacy in the context of the bonds’ terms.

The second justification was an emergency power that gave Finma the discretion to write down the bonds willy-nilly. The very fact this was created casts doubt on whether the contractual condition was met: The government even said the ad hoc decree provided a “clearer” legal
justification for the writedown. The question is whether Finma exercised its discretion appropriately — in particular whether it was proportionate to the goal.

UBS’s more relaxed stance on the deal seems relevant here. Might a smaller writedown have sufficed to secure a rescue, with UBS or another buyer, especially if the sale process had been conducted differently?

These are hindsight judgments. Ultimately the legality of zapping the AT1s must be considered in the context of what was knowable during the maelstrom. But one thing is clear. The more embarrassingly good this deal gets for UBS, the more it’s likely to increase the bitterness of the aggrieved bondholders and their resolve to gain redress.

Chris Hughes is a Bloomberg Opinion columnist covering deals. Views are personal and do not represent the stand of this publication.

Credit: Bloomberg