Buildings of Swiss banks UBS and Credit Suisse are seen on Paradeplatz in Zurich, Switzerland. | Photo credit: DENIS BALIBOUSE

European bank bonds tumbled on Monday after state-backed UBS bailed out Credit Suisse as the elimination of some bondholders raised concerns about wider bank capital and also hammered concerns. bank stocks.

The Swiss authorities’ handling of the Credit Suisse bailout has upended the understanding in the bond market that shareholders would be hit harder than bond investors in such a scenario.

As part of the bailout deal, 16 billion Swiss francs of Credit Suisse bonds, known as Additional Tier 1 (AT1) or CoCos (contingent convertibles) debt, will be written down to zero on the orders of the Swiss regulator in the context of the merger with UBS, a decision that surprised bondholders.

AT1 bonds – a $275 billion sector also known as “contingent convertibles” or “CoCo bonds” – can be converted into shares or canceled if a bank’s capital level falls below a certain level. threshold.

Zero writedown at Credit Suisse will lead to largest loss in AT1 market of $275 billion to date, eclipsing 1.35 billion euros ($1.44 billion) bondholders of Spain’s Banco Popular lost in 2017.

“The takeover of Credit Suisse by UBS was done quickly and should have reassured the market that we didn’t have another bank meltdown. However, what it did was expose the bond issues. AT1,” said Russ Mold, chief investment officer. at AJ Bell.

AT1 bonds are a form of super subordinated debt that converts into equity or is canceled if a bank’s capital levels fall below a certain threshold, depending on the terms of each individual instrument.

Read also | Rush to safety eases as markets digest Credit Suisse bailout

Credit default swaps of European lenders – instruments used to hedge against exposure to default risk – have expanded significantly across the banking sector.

In the bond market, Credit Suisse Additional Tier 1 (AT1) bonds traded as low as 1 cent on the dollar on Monday as investors braced for a wipeout.

AT1 bonds from other banks fell as the Credit Suisse write-off raised concerns about investing in such debt issued by other banks.

European supervisors attempted to halt a rout in the convertible bank bond market on Monday, saying owners of such debt would only suffer losses after shareholders were eliminated.

Bid prices on AT1 bonds from banks including Deutsche Bank, HSBC, UBS and BNP Paribas fell 9 to 12 points on Monday, sending yields significantly higher, according to Tradeweb data.

A UBS AT1 bond redeemable in January 2024 was trading at a yield of nearly 29%, down from 12% on Friday, demonstrating just how more expensive such debt could become.

“CS’ specific situation is mostly entrenched now, but now is not the time to be complacent,” said Wolfgang Felix, senior analyst at credit firm Sarria Limited. “CoCos are down across the board this morning as investors realize that these bonds contractually circumvent the concept of top priority to their own disadvantage.”

“So the crowd is angry and scared and looking for the next best target. The focus is on other CoCo issuers, which include most of the major European banks. This is not a good situation.”

Funds that track AT1 debt also fell sharply.

Invesco’s AT1 Capital Bond exchange-traded fund was last down 9%, while WisdomnTree’s AT1 CoCo bond ETF was listed down 7%.

Shares of Credit Suisse fell 64.5% while shares of UBS Group fell 16%.

Bank stocks then recouped some losses throughout the morning and as of 11:06 GMT were down 1.4%.

The European banking index has lost around 18% this month after the recent failure of several US regional banks, starting with Silicon Valley Bank, prompted a sell-off in bank stocks.

The uncertain situation was also reflected in the increased cost of insuring exposure to other banks’ debt in the credit default swap (CDS) market.

UBS CDS widened from 63 basis points to 180 basis points – levels last seen more than a decade ago. Among other lenders, Deutsche Bank and UniCredit posted some of the largest increases at 20 basis points and 13 basis points respectively, according to data from S&P Global Market Intelligence.