Has Switzerland Destroyed Confidence In Corporate Bonds?

Published on

After being out of the popular media the way stocks and crypto have hogged it in recent years, bonds are now back in the news. First with the Fed hiking rates on the overnight lending rate to banks, which had an effect of increasing yields on new short term treasuries vis a vis long term ones in what is called yield curve inversion.

Mostly shunned by individual investors looking for high returns in the past but used mostly by professional fund managers, banks, corporates, and central banks doing quantitative easing, it has recently enjoyed a resurgence even among ordinary investors.

Get The Full Ray Dalio Series in PDF

Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q4 2022 hedge fund letters, conferences and more


A Damper On Corporate Bonds

However some recent news put a damper on corporate bonds in particular, especially one of a special type. Credit Suisse, a storied 166 year old Swiss bank, recently collapsed after it could no longer get additional capital from its major investors, in particular the Saudi National Bank.

Credit Suisse stock (NYSE:CS) in the NYSE dropped from $2.50 to $1.88 a share in mid March 2023 due to a perception that it was undercapitalized and might follow the bank closures of Silicon Valley Bank, Silvergate and Signature NY.

Hence a rescue was engineered by the Swiss authorities who merged it with the Union Bank of Switzerland for a low $3.25bn (CHF 3bn) price tag. But in order to make the deal happen immediately at a low value, the Swiss cut the value of the Credit Suisse corporate bonds to zero to remove any liability owed to creditors.

Legally it was in their power to do so, as these bonds were not ordinary corporate bonds but were of a special type.

Additional Tier 1 (AT1) bonds, also known as Contingent Convertibles or “CoCos”, are a special type of high yielding bond that came into fashion after the global 2008 banking crisis. Banks were forced to increase their capitalization but needed to do so without relying on taxpayers as the spate of massive government bailouts had made it politically unpopular to do so.

The current market, prior to the Swiss move, was around $250bn for these AT1s. Many investors are now reluctant to touch these types of bonds with a ten foot pole.

What these AT1 bonds do is to promise the buyer a higher yield in exchange for the possibility of being converted into equities (debt to equity) if the bank suddenly struggles with a huge risk, or even an outright reduction to zero value if the bank fails.

Bonds fall in the liabilities portion of a bank balance sheet. As everyone knows, assets equals liabilities plus equity. From a bond buyer’s standpoint, a bond is an asset that pays annual dividend yields and returns the principal after the maturity period is reached.

While a corporate bond is not as secure as a government bond, the failure of big banks has not been a common occurrence after the 2008 failure of Lehman Brothers.

From a bank’s standpoint however, a bond is a liability or a debt payable over time. With the decision of the Swiss authorities to make the AT1 bond zero value, it then seems that this bond acted like a “risk-on” and not a “risk-off” asset as some may have mistakenly thought.

Most conservative fund managers keep most of their money in risk-off assets and only add a small percentage of risk-on assets like volatile stocks or crypto to improve their returns. Unless they are a high risk hedge fund, they don’t really put a lot of risky assets in their funds.

Reading The Fine Print

Unfortunately if they didn’t read the fine print, it turns out they were buying a really risky bond.


Although it was in the fine print, it seems that many fund managers who invested in the Credit Suisse AT1 bonds were literally left holding the empty bag. If it were a game of musical chairs, they were the ones left without a chair when the music stops. They are currently organizing and talking to their lawyers about pushing a lawsuit.

Compounding matters is that normally bond holders get preference in the order of payment during bankruptcies and closures over stock equity shareholders. This was not followed by the Swiss authorities, who cut down the bond value to zero but disbursed partial compensatory equity to the shareholders. This has made the Credit Suisse AT1 holders extremely furious and it has been reported that they are planning a lawsuit.

The Bank of England and the EU central banks have made it clear that bondholders will always get priority over shareholders since it is the normal way of doing business. Clearly the out of pattern Swiss move to pay shareholders instead of bondholders has added more tension to an already distraught global banking sector.

Banking is a business that relies on trust from the public. What the Swiss did was an irregular move outside of what is normally accepted practice that simply makes things worse for banks globally who want to tap these AT1 bonds as financial instruments to add more capital to stay afloat.

Source: various media reports from CNN, FT, CNBC, WSJ, and other business media sources