Credit Suisse’s Catastrophe Bonds Should Outlive the Bank: DBRS Morningstar

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Bonds designed to insure Credit Suisse Group AG against disaster could outlive the bank.

Credit Suisse’s Operational Re bonds, insurance-linked securities that cover the bank against perils such as falling victim to fraud and accounting errors, should remain unaffected by the bank’s government-brokered sale to UBS Group AG, according to rating agency DBRS Morningstar.

That means holders of the so-called catastrophe bonds could end up doing far better than investors in the firm’s junior bonds, which have been written off by Swiss regulator FINMA as a part of the UBS deal. The move drew bondholder ire and spurred a global selloff in this kind of additional tier 1 debt.

“FINMA’s decision to wipe out the full value of Credit Suisse’s AT1 bonds should not affect these cat bonds,” Marcos Alvarez, global head of insurance at DBRS Morningstar, told Bloomberg News. “I believe the cat bonds will not be triggered nor redeemed in the short term.”

A spokesperson for Credit Suisse declined to comment.

Cat bonds are more often used to provide cover against hurricanes and other natural disasters than bank risk. The Credit Suisse notes would be triggered with principal wiped out if certain operational risk events specified in their documentation occur. The bonds have not yet been triggered or written down, according to a person familiar with the matter, who declined to be identified discussing non-public details.

The Swiss bank first sold this form of notes in 2016 as a way of reducing the capital it was required to hold against operational risk. Zurich Insurance Group AG provided the underlying insurance contract, part of which was securitized into the cat bonds that are issued from a Bermuda vehicle. Zurich declined to comment, citing client privacy.

Credit Suisse pitched the bonds to investors in its prospectus as a win-win for both the bank and bondholders: the lender benefited from a reduction in its risk-weighted assets, while investors got the coupons.

Yet in the aftermath of scandals caused by the collapse in 2021 of specialty-finance firm Greensill and hedge fund Archegos Capital Management — both of which left multi-billion-dollar headaches for Credit Suisse — the cat bonds traded at a heavy discount to par.

The notes required more than one operational risk event to occur for the bonds to be written down, leading some in the market to wonder if those two blunders could see the noteholders lose their principal. In the end, the original notes were retired and a new set were issued earlier this year.

“My assumption is that the bonds are not triggered during the forced merger process, the coverage will be novated to the surviving entity, in this case UBS, until the maturity of the bonds,” Morningstar’s Alvarez said. “Since these cat bonds were issued to reduce risk-weighted assets of Credit Suisse, I would assume UBS will keep the coverage.”

–With assistance from Tasos Vossos.

Photograph: A Credit Suisse logo on the roof of the Credit Suisse Group AG headquarters in Zurich, Switzerland, on Thursday, April 8, 2021. Photo credit: Stefan Wermuth/Bloomberg