As the value of Credit Suisse shares and bonds fell sharply last week, some investors saw the sell-off as a buying opportunity, expecting regulators to step in to prevent Credit Suisse from collapsing completely. They were right.
Swiss regulators have approved a deal to buy the bank by its domestic rival UBS, although hedge funds that have rushed to buy the beaten-down bonds from the famous Swiss bank have faced mixed results.
Among the funds to bet on the bailout deal were two that specialize in buying the bonds of companies on the brink of bankruptcy, according to two people with direct knowledge of the funds’ deals: Redwood Capital Management, which held bonds in defaulted China; real estate store Evergrande and 140 Summer. Goldman Sachs, Jefferies and Morgan Stanley were among the banks that facilitated trades between investors.
Both 140 Summer and Redwood declined to comment. Goldman Sachs and Jefferies declined to comment. Morgan Stanley did not immediately respond to a request for comment.
Trading in Credit Suisse bonds rose sharply late last week as tensions rose in the banking sector, according to official trading data.
There were two types of trades that investors made: one that was set up to make money, the other that was set up to lose money.
The first is in Credit Suisse’s regular bonds: debt borrowed by the bank at a fixed interest rate to be repaid over a period of time. Those bonds were trading around 60 cents on the dollar at the end of last week, meaning anyone selling took a 40 percent loss on their original value. Traders said some bonds had already surged on Sunday after the deal, now that the immediate threat that Credit Suisse would walk away from its debt had passed.
Because of the risks involved, banks quoted buy and sell prices that were unusually far apart, protecting them from sudden price changes. It also set up banks to make more profit between the price they paid for the bonds and the price they sold them for.
The second deal that investors jumped into was Credit Suisse’s roughly $17 billion so-called AT1 bonds. This is a special type of debt issued by banks that can be converted into equity in case of problems. Holding this debt was inherently riskier because it carried the chance that the bondholders would be wiped out. Investors saw buying bonds at just 20 cents on the dollar as a kind of lottery ticket — a long shot, but with a big payoff if it panned out.
Credit Suisse came under intense pressure last week as turmoil over the collapse of the California-based Silicon Valley bank spread across the Atlantic.
On Sunday, Switzerland’s financial market watchdog, or Finma, approved a deal for UBS to take over its smaller rival. “The transaction and the measures taken will ensure stability for the bank’s customers and for the financial center,” he said Finma statement.
It said AT1’s bonds would be wiped out as part of the deal to add about $16 billion of equity capital to support the UBS takeover.
That raised eyebrows among some investors because it reversed the normal order in which holders of a company’s various assets expect to be paid in bankruptcy. Equity investors are at the bottom of this repayment list and usually lose all their money before other investors.
In this case, however, regulators decided to open the AT1 bond conversation to equity to help the bank, while still offering Credit Suisse shareholders one UBS share for every 22.48 Credit Suisse shares held.
“This acquisition is attractive to UBS shareholders, but let’s be clear, as far as Credit Suisse is concerned, this is a bailout,” said Colm Kelleher, chairman of UBS. “We have structured the transaction to preserve the value remaining in the business while limiting our downside exposure.”