Source: Zhitong Finance and Economics

Although the Swiss government has a complete write-down$Credit Suisse (CS.US)$The surprise move for additional tier one capital (AT1) bonds has settled, but it will take a long time for the bond market, which provides shock absorbers for banks, to regain investor trust.

UBS.US and Credit Suisse reached a merger agreement "brokered" by the Swiss government on March 19, local time. UBS bought shares of Credit Suisse shareholders for a total consideration of 3 billion Swiss francs (US $3.237 billion), while $17.2 billion of Credit Suisse AT1 bonds will become "worthless". Under normal circumstances, the order of payment of AT1 creditors should take precedence over common shareholders.

The move caused an uproar in global markets, hitting the $275 billion AT1 bond market.

It is reported that AT1 bonds, also known as contingent convertible bonds (CoCos), were launched after the 2008 financial crisis to act as shock absorbers when banks' capital levels fall below a certain threshold. They can be converted into equity or completely written down and are considered a high-risk bank debt.

While AT1 bond prices have stabilised, many believe the AT1 bond market could shrink and cause more pain for banks as the cost of issuing such bonds becomes higher.

The impact is not over yet.

Eric Larsson, managing director of Alcentra, an asset manager, said the market would be divided. He added that well-capitalised banks would be able to issue AT1 but would need to pay more to investors, while smaller banks "may be shut out for the time being".

If small banks do not have access to the AT1 market, they may face higher funding costs on other capital instruments, which could reduce their lending and increase the risk of recession in countries, particularly in Europe, where banks dominate the AT1 market.

Fears that banks would not be able to sell AT1 bonds dragged down share prices, with European bank stocks falling 13 per cent in March, the biggest monthly drop in two years.

"the AT1 bond market is hurting, but you won't see any new bond issuance," said Mark Holman, a partner at TwentyFour Asset Management. He points out that current yields are too high for banks to issue.

The average yield on European AT1 bonds has jumped to about 14.5 per cent from just over 7 per cent in February, according to the data.

Keith Thomas, head of securities litigation at law firm Stewarts, said that if more bondholders were out before shareholders, it would "call into question this asset class".

Thomas said that like other financial lawyers, he had been dealing with questions from Credit Suisse AT1 bondholders about whether to file a lawsuit against the Swiss ruling.

European regulators say they will continue to let shareholders bear losses first if a bank fails, helping to appease panicked investors. Hong Kong and Singapore also said they would abide by the traditional order of claims.

Analysts at ING said it was "doubtful" whether banks would be able to issue a new AT1 "in the near future", even with assurances from European regulators.

"the rules are a little bit torn up," said Gerard Fitzpatrick, head of fixed income at Russell Investments. "A lot of people will be scared and will withdraw from AT1 bonds.

Ushered in the opportunity of "bottom-reading"?

The price of AT1 bonds has rebounded, but it is still well below where it was before the Swiss authorities made the decision.

WisdomTree exchange-traded funds, which track banks' AT1 bonds, have fallen 11% in the past two weeks. Before Credit Suisse was bailed out, Credit Suisse AT1 bonds accounted for less than 3 per cent of the fund.

Deutsche Bank AT1 bonds are now trading at 74 per cent of face value, off last week's low of about 67 per cent, but still below levels seen before credit suisse's AT1 bond writedowns, according to Tradeweb. The situation is similar for UBS AT1 bonds, which trade at about 64 per cent of face value.

Some investors saw an opportunity after the sharp fall in the price of AT1 bonds.

Bjoern Jesch, global chief investment officer at DWS, says these bonds have never been cheaper than equities.

Peter Doherty, head of investment research at Arbuthnot Latham, a private bank in London, said the group last week added more European AT1 exposure to clients' portfolios.

Doherty said the Credit Suisse panic led to very high yields on AT1 bonds of other banks. He added that he thought it was unlikely that more big European banks would fail because the banking sector was still well capitalised.

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