Black Friday for European stock exchanges, as traders worry about a possible crisis in the sector after the forced marriage between Credit Suisse and Ubs. The European banking sector has been under stress since the Swiss government decided to burn 16 billion Credit Suisse AT1 bonds, upsetting the eurozone hierarchy in which stocks are canceled before bonds (in theory, in fact, AT1s are higher than stocks in liquidation level).
AT1 (Additional First Level) bonds are a tool created after the 2008 financial crisis to make European banks more resilient. They are financial debt instruments issued by banks to absorb losses without affecting the issuer’s operations. what does that mean? That when the bank suffers from solvency problems and the CET1 capital ratio falls below a certain limit, the bonds are converted into bank shares.
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To make matters worse, already somewhat strained, came the move of Pfandbriefbank and Aareal Bank, banks that finance real estate and infrastructure projects. The two German lenders announced that they would not pay back AT1 bonds that had a short-term “call” option (for simplicity, let’s say a maturity type), and decided to pay investors higher rates rather than divest. For bonds issued by Deutsche Pfandbriefbank, the coupon rose from 5.75% to 8.42%. A legitimate step, but the market considers it unfair and rare because it undermines the relationship of trust between issuers and investors.
Why did they do that? Because the two banks did not want the bonds to run out and because if they had paid off the bonds they would have had to issue new ones at much higher rates. The company said in a statement that Deutsche’s decision to acquire Vandebrebank was made after a “careful assessment of various factors, including market conditions and economic costs.” However, traders question the sector’s ability to repay the subordinated debt, and so the sector crashes in the financial markets, marking another Black Friday. However, it should be noted that some investors, worried about the somewhat uncertain situation, prefer not to hold their positions over the weekend and thus eventually sell and buy back on Monday.
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Today is the third day of losses for Deutsche Bank. Its shares fell by 12%, losing a fifth of their value in one month, only to recover from their lows and close at -6.75%. On the other hand, the cost of 5-year credit default swaps (derivatives that provide a hedge against bond debt default) has jumped to the highest levels of the past four years. The German bank has undergone a restructuring like Credit Suisse, but unlike the latter, has returned to profitability in recent quarters. German Chancellor Olaf Scholz assured that “the bank is very profitable” and that “there is nothing to worry about” while European Central Bank President Christine Lagarde reiterated to the heads of state and government gathered at the Euro Summit that the European banking system is solid and that the ECB is able to provide liquidity if needed. However, Lagarde decided to miss the press conference of EU chiefs Michel and the von der Leyen Commission, a signal that some operators considered to be interpreted. Investors are increasingly concerned about contagion risks, given that Deutsche Bank is considered one of the largest international banks and has a strong presence in major European cities, including Italy.
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