Canadian banks' AT1s join selloff after Credit Suisse rescue

Michael Nagle/Bloomberg

Canada's financial institutions' regulator moved to reassure investors as the country's riskiest bank debt joined a global selloff after the value of some Credit Suisse bonds was wiped out in the bank's takeover by UBS Group. 

Canada's "capital regime preserves creditor hierarchy which helps to maintain financial stability," the Office of the Superintendent of Financial Institutions said in statement on its website. 

Prices of Canadian limited recourse capital notes, known as LRCNs, fell between 2 cents and 5 cents on the dollar Monday before OSFI's announcement, according to people familiar with the matter who asked not to be named. That has widened the spread on the notes by over 60 basis points compared with Friday's levels, the people said. Specific levels vary depending on the security.

The bonds are another form of so-called additional tier 1 securities, issued by financial institutions and designed to act as a shock absorber in the system. They can be converted to equity to bolster a bank's capital if it runs into trouble. 

Over the weekend, Swiss regulators triggered a complete writedown of 16 billion francs ($17.2 billion) of Credit Suisse's AT1 bonds as part of the rescue plan for the venerable bank. While it wasn't a surprise that the bonds were likely to take a loss, some investors in the instruments were shocked to be wiped out when Credit Suisse's shareholders were not.

Under Canada's capital regime, additional tier 1 and tier 2 capital instruments are "to be converted into common shares in a manner that respects the hierarchy of claims in liquidation," said OSFI, referring to a situation in which a bank would reach non-viability status. "Such a conversion ensures that additional tier 1 and tier 2 holders are entitled to a more favorable economic outcome than existing common shareholders who would be the first to suffer losses, OSFI said. 

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"Our view is that we don't expect LRCNs would be wiped out before common equity," said Furaz Ahmad, a Toronto-based corporate debt strategist at BMO Capital Markets. "OSFI has said that they would convert to common equity, since that is more consistent with traditional insolvency norms and respects the expectations of all stakeholders."

Earlier Monday, European authorities sought to restore investor confidence in banks' AT1s by publicly stating that they should only face losses after shareholders are fully written down. AT1s from UBS Group and Deutsche Bank fell by more than 10 cents earlier on Monday. 

—With assistance from Christopher DeReza.