Hedge funds flock to Credit Suisse AT1 bonds after Swiss rescue

Pedestrian walks past a logo of Credit Suisse outside its Hong Kong office building.

LONDON Reuters -- Distressed debt investors and large hedge funds are buying additional tier 1 bonds at rock-bottom prices from Credit Suisse after they were written down to zero in the Swiss bank's rescue by cross-town rival UBS.

Under the UBS deal, the Swiss regulators determined that Credit Suisse's AT 1 bonds with a notional value of 16 billion Swiss francs $17.35 billion would be wiped out, a decision that shocked global credit markets and angered many holders of debt who believed they would be better protected than shareholders.

At 1 bonds, which can be converted to equity, rank higher than shares in the capital structure of a bank. Bondholders will usually come before shareholders if a bank is having trouble getting their money back.

At 1 bonds issued by other European banks tumbled on Monday as the treatment of Credit Suisse AT 1 bondholders highlighted the risks of this type of debt.

The bonds, now trading at about 0.03 cents on the dollar, have been an opportunity for hedge funds to take punts that the merger of UBS Credit Suisse might not proceed or that the Swiss regulator might reverse its decision, six traders and dealmakers said.

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Robert Southey, a broker at Southey Capital in London, said that bonds worth several hundred millions dollars had been traded since Sunday afternoon, mostly between large U.S. investors. The bonds are publicly traded, so opportunistic buyers can hoover them up from funds and private banks looking to offload.

Southey expected to hold bonds for an extended period before they paid off, because the buyers included a mixture of hedge funds and deep distressed debt funds.

Some of the buyers intend to join groups that would litigate to improve the odds of cashing in on bonds, Southey said. The AT 1 holders are talking about possible recouping some of their losses via the courts, according to Quinn Emanuel.

He said that other law firms received many inbound calls from holders and potential buyers.

Louis Gargour, the chief investment officer and managing partner of $550 million hedge fund LNG Capital, said legal action could increase the spoils for investors swooping on Credit Suisse AT 1 s, but taking advantage of the sell-off in similar bonds issued by other banks was the wiser trade.

The most compelling trade is other large independent and well-capitalised European institutions such as Deutsche Bank, Societe Generale, and Intesa, where you can achieve significant long-term yields by taking the view that AT 1 s will not be converted into equity, said Gargour.

European regulators, including the European Central Bank, said on Monday they would continue to impose losses on shareholders before bondholders.