The effects of the Credit Suisse bailout: the increase in the cost of convertible bonds threatens to further restrict credit

The Credit Suisse bailout has shaken the European banking chessboard.

In the heart of the Old Continent, although outside the jurisdiction of the ECB, the sale of a Swiss symbol to the UBS bank was formalized last week.

An operation in which the usual order of priority has been upset: the shareholders recovered part of their investment, while the holders of the

(acronym for convertible contingent bond) have lost everything.

In practice, it has made these bonds more expensive for banks, which reinforce the capital cushion in times of crisis, since their holders are now demanding higher returns.

In other words, the entities will pay more for their financing and, therefore, comes the threat of an even greater restriction on the granting of credit to customers.

Holders of Credit Suisse convertible bonds, known as AT1, lost $17 billion (about 16 billion euros), which were fully written off.

The shareholders, however, went to the 3,000 million exchange.

An amount, yes, very far from the 7,500 million in which the entity was valued before the operation.

"Switzerland has crossed a red line whose immediate consequence has been to make debt holders nervous," explains Joaquín Maudos, deputy director of the IVIE and professor at the University of Valencia.

In fact, the markets strongly increased the required return, almost doubling it in some cases.

“Bank financing is now more expensive and banks will lend less,” Gordon Shannon, a fund manager at TwentyFour Asset Management, told Bloomberg.

To avoid a bigger disaster and cut the bleeding, the ECB came out on Monday to try to stop this vicious circle: it issued a statement warning that, in the event of a crisis, in Europe the losses will be assumed first by shareholders and creditors and, only later, by the holders of those bonds.

"The EBA [European Banking Authority], the ECB as supervisor and the SRB [Single Resolution Board] have been specific in terms of the order of priority that applies in Europe," these institutions emphasized in a joint note.

In other words, it guarantees that your investment will have preference.

The announcement calmed the markets, both in the Stock Market and in the demands of the negotiation for coconuts

which stopped falling.

Although nervousness had already permeated a market valued at more than 250,000 million euros (in Spain, listed banks have more than 20,000 million).

“If it is not able to completely restore confidence that the rules of the game are respected in the order of assumption of losses, the cost of financing that banks support will become more expensive.

And this, as is logical, they will transmit to their clients”, Maudos ditch.

Convertible contingent bonds are a hybrid issue: they have debt (they pay interest to the investor) and equity (can be used to absorb losses) characteristics.

In fact, if a series of requirements are met, the issues known as AT1 can be computed as additional capital.

In addition, they do not have a specific maturity, but are perpetual, although the entities reserve the right to redeem the bond once a certain period has elapsed since its launch (usually five years).

"They were created in the previous crisis to reinforce bank capital because it is practically comparable to the highest quality and can be converted when it falls below a certain level," says Ángel Berges, vice president of International Financial Analysts (AFI).

Regulators require these internal bailout buffers so that they can be released to take losses in times of bankruptcy.

Of course, previous steps must be executed before: the highest quality capital, the CET1

, plus the reserves generated by the profits of previous years.

Then the

would be pulled and then the subordinated bonds.

The idea, after all, is that taxpayers are not the first to pay the piper.

The precedent of the Popular

For banks it is also attractive, since it allows them to convert them into shares or their value can even be reduced if the entity is in trouble.

There is a paradigmatic case that is used in European organizations as an example: the resolution of Banco Popular, which ended up being absorbed by Santander for one euro in 2017. Then, everyone saw their money disappear: shareholders and debt holders (both the convertible contingent bond and the subordinated one).

On that occasion, investors did not recover anything and taxpayer protection and financial stability prevailed.

“A higher than expected risk has surfaced with

.

This makes financing more expensive: investors will ask banks for more profitability for this risk and, therefore, they will grant more expensive loans”, says Leopoldo Torralba, economist at Arcano Economic Research.

In this context, financial groups will have to choose in future maturities whether to issue new AT1 debt at a higher cost or look for other ways to raise capital, something difficult in a context of uncertainty like the current one.

According to JPMorgan, the need to refinance convertible bonds may be a problem in the short term.

An idea that Standard & Poor's abounds: "AT1 investors run the risk of suffering large losses as part of any bailout, whether as part of a formal resolution or a market solution to help a bank in difficulty."

A headwind for a financial sector that still fears a return of the stock market panic.

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