(Bloomberg) -- European regulators are rushing to reassure investors that shareholders should face losses before bondholders after the takeover of Credit Suisse Group AG wiped the bank's Additional Tier 1 debt.
The clauses that led to the bonds being marked to zero aren't common. Only the AT1 bonds of Credit Suisse and UBS Group AG have language in their terms that allows for a permanent write-down and most other banks in Europe and the UK have more protections, according to Jeroen Julius, a credit analyst at Bloomberg Intelligence.
Yet, judging by the market action, investors aren't sticking around to find out. All kinds of risky bank debt tumbled on Monday and analysts predicted far-reaching consequences to Europe's funding market. The market for new AT1 bonds will likely go into deep freeze, traders said.
“This just makes no sense,” said Patrik Kauffmann, a fixed-income portfolio manager at Aquila Asset Management, who holds Credit Suisse CoCos. “Shareholders should get zero” because “it's crystal clear that AT1s are senior to stocks.”
Perpetual notes issued by Deutsche Bank AG, Raiffeisen Bank International and BNP Paribas SA all dropped on Monday. Deutsche Bank's £650 million ($792 million) 7.125% note fell the most ever.
The wipeout of 16 billion francs ($17.2 billion) of Credit Suisse's so-called AT1 bonds is the biggest loss yet for Europe's $275 billion market in these securities, which were created after the financial crisis to ensure losses would be borne by investors not taxpayers.
In a typical writedown scenario, shareholders are the first to take a hit before AT1 bonds face losses, as Credit Suisse also guided in a presentation to investors recently. That's why the decision to write down the bank's riskiest debt — rather than its shareholders — has provoked a furious response from some of the bondholders.
Junior creditors should bear losses only after equity holders have been fully wiped out, according to a joint statement from the Single Resolution Board, the European Banking Authority and the ECB Banking Supervision.
Other European officials also weighed in. ECB Governing Council member Ignazio Visco said at an event in Milan that that regulators have the tools to deal with liquidity problems, but there are no issues currently.
Italy's Finance Minister Giancarlo Giorgetti said the risk for Italian banks is “not significant.” He added that he was “surprised” by the Swiss decision to prioritize shareholders over some bondholders.
If the AT1 new-issue market reopens, equity conversion may become the dominant loss-absorption mechanism to reassure investors that they won't be wiped out ahead of shareholders, BI's Julius said.
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