What Lenders can Learn from the Credit Suisse AT1 Debacle
Much ink has been spent, and more will no doubt flow, following the write-down of Credit Suisse’s AT1 notes. The implications of the Swiss regulator’s actions spread far beyond that jurisdiction, or indeed that particular asset class, and lessons are being learned by investors across the leveraged finance ecosystem.
Reading the fine print and understanding the documentary nuance of any legal instrument is key to managing risk. In this particular case, the majority AT1s provide for write-down or convertibility into equity in times of bank distress – it appears that the CSAT1s did not contain the latter feature, and this omission was among several unfortunate details for investors.
Another unfortunate aspect was present in jurisdictional nuance – the full implications of the Swiss government not being bound by EU law will now, if it didn’t already, inform investors’ risk analysis. That other central banks and regulators have since made public statements confirming that the same subversion of capital structure priority would not occur in their respective jurisdictions underscores this point.
Contractually, the argument will very likely turn on the presence of a “Viability Event”, though FINMA’s belts and braces approach to the write-down by enacting an Emergency Ordinance provides an additional legislative basis for the action. This does not necessarily mean that the regulator was in doubt of the contractual position, but it does speak to its determination to take the action in question.
A public statement by FINMA acknowledges that CS was granted extraordinary government support, but it is silent as to whether this action had the effect of improving CS’s capital adequacy – this point is unclear and may well be litigated.
What is clear is that the disclosure contemplated a full write-down, and the Risk Factors warned investors that this eventuality would be subject to a subjective determination by FINMA and that this would be beyond Credit Suisse’s control. Article 5(a),which appeared on a Sunday evening and expressly permits the write down of theAT1s, reflected a change in Swiss law banking that had a material adverse effect on the notes – a potentiality that was also covered in the Risk Factors.
The situation serves to highlight the importance of fully understanding contractual provisions, and appreciating the potentially vastly different outcomes caused by jurisdiction, local law, and other factors. Importantly, it also illustrates the lengths to which governments, regulators and central banks will go to sidestep a financial crisis.
These lessons do not just apply to holders of AT1 notes, but serve as a cautionary tale to lenders throughout the leveraged finance markets– understand the terms of your respective instruments, whether AT1s, high yield bonds, leveraged loans or private debt, and consider them through the eyes of your counterparty, the jurisdiction in which it operates, and market conditions at the time – all aspects of covenant analysis that we emphasise in our Leveraged Finance Covenant Training course.
By Sabrina Fox - FLT Founder