The Weird End of Credit Suisse: Do Stocks Outrank CoCos Now?

Lukas Strobl: Credit Suisse’s 167-year history is at an end, and holders of $17 billion worth of low-ranking debt have been wiped out. Now, that is kind of why these so-called additional Tier-1 capital instruments were conceived in the first place—to be able to bail in investors and shield taxpayers in the event of a bank’s failure. One thing is unusual this time: Shareholders—who normally rank below even the lowest-tier bondholders—did not get wiped out. They are losing just over 60% of what their shares were worth on Friday. This rearrangement of seniority is kind of a big deal. I’m here with Elisabeth Rudman, the head of the financial institutions group at Morningstar DBRS, and with Johann Scholtz, our analyst for European banks.

Elisabeth, is this unprecedented? Is this going to change the norms of the financial system?

Elisabeth Rudman: Thank you, Lukas. I guess the fact is that there isn’t much precedent at this point for dealing with the failure of a large complex financial institution, and certainly not since the last financial crisis, after which many of these rules were put in place, and instruments like the AT1 instrument were developed. So all of this is somewhat new. And actually, what we see is that the terms of these AT1 instruments can also be somewhat different for different banks and in different jurisdictions. So clearly there was a shock with the bail in, the writing down of these AT1 instruments, whereas the shareholders still receiving some money, as you pointed out. The terms of the instrument do allow for the regulator to write these instruments down in the case of nonviability, but it wasn’t what was expected. So I think we’ll have to see how the markets continue to react and investors react as well.

Lukas Strobl: Now, most banks issue AT1 debt—is this going to affect the attractiveness of this instrument to investors and, by extension, the cost of raising capital for banks?

Elisabeth Rudman: So, as you say, many of the large banks have these AT1 instruments, and they already have them as part of their capital stack. It’s a regulatory requirement that they have sufficient loss-absorbing debt, and it has been a useful instrument for the banks to date. Certainly it may be now, going forward, more expensive for them to issue those kind of instruments if they need them in the future. So it may make changes to their decisions in terms of how they put together their capital funding.

Lukas Strobl: I see. Now, let’s pivot to this new Swiss megabank that’s emerging from all this—UBS. Johann, despite the bail-in we just discussed, and another 9 billion in guarantees from the Swiss authorities, UBS is down 7%, at times 10% today, more than most of its European peers. What does the near future look like for UBS?

Johann Scholtz: Thanks, Lukas. Yes, I think, you know, under normal circumstances, this would actually have been a brilliant deal for UBS. And we actually still believe that UBS will be able to extract significant value over the long term. You know, they’re looking to cut costs by about 60% on the existing Credit Suisse business. So it’s really going to be a question of how much revenue they will lose during this period, how much revenue attrition there is going to be. I think what this deal does, however, is that it introduces as a certain degree of uncertainty. And obviously uncertainty is the last thing that a bank wants at this point in time. But, you know, I think UBS is much better placed than Credit Suisse to extract the synergies out of these businesses.

And, you know, if you actually look at the businesses that they’re acquiring, there’s three solid franchises in there. And they’re running down the investment bank, which really has been the problem child for Credit Suisse. We believe that over the longer term, there is significant value here.

Lukas Strobl: Thanks, Johann, and thank you, Elisabeth. While we were talking, the European Central Bank announced that even low-ranking bondholders should rank above shareholders, not below. This suggests that Switzerland’s bail-in of AT1 bondholders may have been a one-off after all. But we have seen a lot of firsts in this newest banking crisis. Thanks for watching. For Morningstar, I’m Lukas Strobl.