In the frantic hours after Credit Suisse Group AG’s collapse wiped out $17 billion of the firm’s riskiest bonds, investors pored through the fine print of similar bank notes across the globe. Where, they wanted to know, did the contract language closely resemble that in Switzerland, where regulators shocked the market by writing down their investment to zero.
(Bloomberg) — In the frantic hours after Credit Suisse Group AG’s collapse wiped out $17 billion of the firm’s riskiest bonds, investors pored through the fine print of similar bank notes across the globe. Where, they wanted to know, did the contract language closely resemble that in Switzerland, where regulators shocked the market by writing down their investment to zero.
The one major country they quickly landed on: Brazil.
The rules regulating the $10 billion of global contingent convertible bonds, known as CoCos, issued by Itau Unibanco Holding SA, Banco do Brasil SA and other banks there contain similarly broad language on the triggers that allow regulators to impose losses. All it would take is for the central bank to put it in writing.
Investors immediately dumped them and, even though the lenders are sound, they’re still trading below pre-Credit Suisse-debacle levels — a contrast to the sharp rebound seen in CoCo markets almost everywhere else.
“No one wants to buy that risk while things are unclear,” said Rafael Schiozer, a finance professor at the Getulio Vargas Foundation, a school and think tank in São Paulo. “Investors are waiting for issuers and regulators to clarify exactly in which situation a writedown would occur.”
Bank executives, eager to regain investor confidence in their CoCo debt, have been seeking greater clarity from Brazilian officials regarding just that, according to people familiar with the matter, who declined to be identified because the discussions are private.
Authorities have remained silent publicly on the matter so far, though, in part because the bond terms are based on Brazilian regulation and any potential changes would also require altering the law, the people said.
Representatives for Banco Central do Brasil, Itau and Banco do Brasil declined to comment.
There is, to be clear, little concern today about the health of Brazilian banks. Decades of economic turbulence and high inflation have forged them into cautious institutions widely considered to be financially sound. That makes the prospect of a CoCo bond wipeout seem remote.
And yet, in the wake of Credit Suisse, investors are on edge. The lender’s takeover by UBS Group AG prompted some upset by pulling the pin on the risky notes while setting shareholders up to receive a payout, a move that could theoretically repeat if banking chaos hit Brazil.
Read: Banks Seen Skipping AT1 Calls in Wake of Credit Suisse Shock
CoCos gained global popularity after the 2008 global financial crisis, designed to ensure banks have enough capital to avoid taxpayer-funded bailouts in times of trouble. They include both Additional Tier 1 bonds, which stand to force losses to allow a bank to stay in business, and, in some jurisdictions, Tier 2 notes that only force losses if a bank is no longer viable.
Brazilian banks have almost $8.1 billion of AT1 notes, and an additional $2.15 billion categorized as T2, according to data compiled by Bloomberg.
While they have partially recovered, both a $2.14 billion note from Banco do Brasil and Itau’s $750 million bond remain near lows reached in the wake of Credit Suisse’s wipeout, according to data compiled by Bloomberg.
“Investors may be awaiting more clarity on the overall banking situation before diving too deep into the securities,” said George Ordonez, a strategist at BBVA.
The prices in Brazil are evidence that, for Wall Street, what-ifs matter — especially after the failures of several US regional lenders and the Credit Suisse saga caught some by surprise.
But still, Latin America’s largest financial system is relatively stable and well capitalized, said Conrado Rocha, a banking analyst and partner at Rio de Janeiro-based asset manager Polo Capital. It’s unlikely, he said, that failures there are looming and would trigger CoCo writedowns.
At Itau, a key ratio of stock and retained earnings as a percentage of risk-weighted assets — known as the common equity Tier 1 ratio — ended last year at 11.9%. That ratio, which stands to trigger writedowns by falling below 5.125% for AT1s of 4.5% for T2s, was 12% for Banco do Brasil. Banco BTG Pactual SA’s was 12.6% at year’s end.
The banks also have the option to call several of their CoCos this year, with two of Itau’s AT1s in focus for June and September. The lender already elected not to exercise a March call option because of high refinancing costs.
“Our rule of thumb to investing in EM banks has been that ‘too big to fail’ institutions are too big to fail,” according to Citigroup Global Markets Inc. strategists including Eric Ollom, who recommend buying developing-market AT1s on recent weakness. “The market will wonder at some point whether that is true. That is when we generally like to get involved.”
After Switzerland, Brazil is the largest issuer of CoCos with permanent writedown rules, according to data compiled by Bloomberg. All together, emerging-market banks have about $40.3 billion of dollar, euro and yen CoCos, the data show.
–With assistance from Cristiane Lucchesi.
(Updates to add reference to banks skipping AT1 calls after 10th paragraph.)
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