In an unexpected move the Credit Suisse contingent convertible bonds have been converted and wiped out as a result of the UBS takeover. That's $17 billion in AT1 bonds just gone.
The aim and point of co co bonds - AT1 or contingent convertible - to banks is that they're a form of capital dependent upon how well the bank does. If the bank does well then they're bonds which pay interest and do not dilute other shareholders. If the bank does badly - really badly - then they convert to equity. They may or may not gain actual equity at the conversion. They can just be converted to nothing.
Credit Suisse (NYSE: CS) had a series of such bonds and the list of CS co cos is there. The CS CS 9.75% co co is at that link. As you can see if the bond is triggered there is no equity delivered. The bond just disappears and the money paid for it arrives on the Credit Suisse balance sheet as capital. It's possible to think that if the capital had done so on Friday then the entire UBS takeover might not have been necessary. Even, that both - the forced sale and the co co conversion - was a little too much.
Credit Suisse share price London Stock Exchange This is going to cause ructions in the bond markets. The entire idea of co cos was to provide a new form of regulatory capital. Because they are convertible - contingent upon - then they count as tier 1 capital for a bank. Which is fine, that's what they're for etc. That's also why CS was paying 9.75% on them - there's significant risk attached.
And yet it's still true that debt is supposed to be higher priority than equity. That is, in bankruptcy people get paid off in order. Secured creditors first, unsecured second and equity last, if there's anything left over (which there usually isn't in bankruptcy, rather the point of it in fact). So, a general supposition is that the co co bonds - which are convertibles, contingent upon, yes - will only go to zero if equity has done so first. That's the repayment order which this deal has just overturned. The bonds have gone to zero and the CS equity hasn't. Maybe that's allowable under the terms of the bond issue, but it is something of a surprise to the market.
This is going to change the prices of those co co bonds for all other banks out there. Might, in fact, mean an end to their new issuance as the price to be paid just got much higher. Which isn't, when we think about it, a great idea when we're all looking around for where the banks are going to gain their Tier 1 capital from.