Credit Suisse Rescue May Spell Bad News For Yes Bank AT1 Bondholders

The rescue of Credit Suisse through an acquisition by UBS, backed by the Swiss government, may come as good news for markets and the financial system, but is unlikely to enthuse Yes Bank Ltd.'s additional tier-1 bondholders.  

In a strange way, the scheme announced for Credit Suisse is structured like the Reserve Bank of India’s draft scheme for reconstruction of Yes Bank in March 2020.  

To quickly recap, the draft scheme from the RBI had specifically articulated that additional tier-1 bonds worth Rs 8,500 crore of Yes Bank would be written down to zero, which was not mentioned in the final scheme notified by the government. The bank still wrote off those AT1 bonds. That decision was struck down by the Bombay High Court, but the bank has since challenged it in the Supreme Court. 

To come back to the Credit Suisse deal, the local regulator Financial Market Supervisory Authority, or FINMA, specifically takes a view that it is necessary to write-down the additional tier-1 bonds of Credit Suisse due to the extraordinary nature of the bailout brokered by the Swiss government.  

This flies in the face of the conventional view that equity investors are the first to face the brunt of any crisis. The Credit Suisse deal actually exemplifies what Yes Bank’s defence was in the case before the high court that considering the extraordinary restructuring that they underwent to save the institution, a write-down of additional tier-1 bonds was necessary. This just underlines the fact that while convention or precedent often need to be acknowledged, they cannot be the only basis for any legal judgment. 

Precedents change. Conventions change. And each situation is unique, so the reactions from regulators necessary to safeguard the system will also have to be different.  

One look at the U.S. shows the unprecedented coordinated approach by the government, the Federal Reserve, depositors insurance and other larger banks to prevent the bank failures from turning into a systemic episode. 

In the case of Credit Suisse, the only other option—apart from a UBS deal—would have involved a full or part nationalisation, which would have hurt equity investors and bondholders.  

In the Yes Bank episode, the lender's asset quality woes had reached a point where its capital was eroded, and without a bailout, additional tier-1 bondholders would have either been converted to equity or been written-down. The manner in which the reconstruction scheme was finally structured ensured that credibility was brought in through institutional investors led by State Bank of India as the anchor, while writing off AT1 bonds enabled the bank to recover from its troubles over time and attract a fresh set of investors. This has enabled the bank to survive and now finally grow. 

The RBI and the government-backed reconstruction scheme worked precisely because of the call that those investors who had invested in the riskier tier-1 bonds must foot the bill, so that public depositors and the system are protected. Once again, there are retail bondholders of Yes Bank who claim that they have been mis-sold these bonds by the bank, and that is an issue that needs to be seen distinct from the actual view on whether a bank can decide to write-down bonds before equity is wiped out. Those two issues are distinct and must not be conflated, especially in a court of law.  

Essentially, what has been done today when the Swiss government brokered UBS' takeover of Credit Suisse is also in the larger interest of protecting depositors and preventing a contagion effect in domestic and global markets. Aggrieved tier-1 bondholders of Credit Suisse are sure to take the legal route, just like those who held such Yes Bank debt did.  

It is, however, increasingly becoming clear that additional tier-1 bonds issued by banks with all these covenants in place can be written-off or converted when a bank is in crisis. Investors would do well to know this risk when they invest in such bonds, and not expect any seniority vis-a-vis equity investors when a bank is on the brink.  

It would be curious to see what happens in the next hearing of the Yes Bank case. It is extremely likely that Credit Suisse's takeover by UBS and the additional tier-1 bond write-down will find a mention in the Yes Bank defence before the Supreme Court.  

T Bijoy Idicheriah is a senior financial journalist who has been writing on the world of banking and central banking for 17 years.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.