Swiss AT1 Bond Carnage, Leisure Sector Risk

among other things, for Bloomberg Intelligence in Princeton. Companies in those industries are highly exposed to the tightening and financial conditions that's happening as we speak, and we'll be getting her insight in a little bit, but before we do. Tassos Bossos with Bloomberg News in London, you've been at the epicenter of the credit Swiss collapse. It's a Swiss bank, had been struggling for a while. All of a sudden

it was gone. One of the biggest banks in the world, over half a trillion dollars in assets, participation in all the main markets globally. Can you walk us through what happened there. I mean, indeed, it is a shark for the banking community, that's what you call it GC for normal people. That's a global systemically important bank, one of the bank that's not supposed to go down that you need in order to have a financial system that is function,

that's working properly. Now. The problem the Credit Swiss, though, is that they were they were involved in so many interesting things over the years, from financing of yours and the securitization of it to Archie collapse for example, and they suffered a social media storm back in late twenty twenty two. This is when they saw out those because people thought that Credit Swiss may not be around in the month's time, for example, they want to take the

money out. They did manage to survive that, but they reached the point earlier this month where they said, well, the numbers that we were releasing to the investor over the years, they may have some problems, and the USSC I said that that could be the case. This is when a panic ensued that was maximized by the fact that there was already a brewing crisis in the regional banking system in the US. So a number of counterparties started getting credit insurance against Credit Swiss, that is, through

some contracts called credit default swaps. This is when everyone started paying attention. They said, okay, something is wrong. Is here this bank, even though it's massively important, seems to be going past Now we have to do something, So they started taking money out of it. At some point out those reached ten billion dollars a day, and things came to a head last weekend when the Swiss authority

said we need to do something. What is that a shotgun marriage between the two national champions, that is UBS and Credit Swiss. And as part of this agreement, they said, somebody needs to take a loss. Who is that going to be? That's going to be some people who hold some funky instruments called additional tier one bonds. And this is when all hell broke loose when they were written down seventeen billion of them. So before we get that

there was a there's basically a shotgun marriage. Basically, UBS, the biggest or one of the biggest banks, the other biggest bank in Switzerland acquired Credit Swiss for three three billion dollars or so um. Basically of course, sale, how's that all shaking out what's going on at that point. Well, at that point, UBS said, Credit Swiss has quite a bit of um let's call it baggage. Chances are if we acquire them, we're going to be taken to court by some of their ex clients for a number of

different scandals that were involved over the years. There is what in banking terms you're called a lot of accumulated bad will. So somebody needed to take a loss. Now, at first there was an issue of paying almost nothing or a very lobal price for the share of Credit Swiss. There was some pushback on that. Eventually that the price tag was raised three billion, but still somebody needed to take a loss because UBS was not going to acquire

the whole capital structure of Credit Twists. You mentioned a type of debt that we've been looking at very closely, and you've broken a lot of news on eighty one. Some people refer to it as cocos that essentially became worthless. Let's start with the obvious question, what is an eighty one for? You know, the person on the street who's not following this closely. When Lehman collapsed, people thought, the regulators thought, okay, Lehman was capitalized to a certain extent,

but it was overleveraged. We need to come up with some bonds that provide capital so when you are going into trouble as a bank, you can rely on that capital to stay alive. That's in very basic terms. So they try to come up with a new type of bonds that when your capital levels decline below a certain level, these bonds can be triggered. What that means is that they can be converted into equity or written to reduce your liabilities. And that was called additional Tier one because

it stand just above common equity. And when it was created back in twenty ten, that was the Basil Committee, what we know as Basil three. It was hailed as the greatest innovation we've seen of a several decades in the banking market. This is what we're going to save us from future crisis. I think this is going to be the end of history for banking capital instruments. And

things went well for the past thirteen years. Well, there were some wobbles along the line, some write offs in Spain for example, and there was some concerns at some point that Deutsche Bank several years ago couldn't pay coupons of these bonds. But generally speaking, things were smooth. So if these bonds essentially became worthless even after equity investors recovered something, what does that mean for the eighty one

market as a whole. Well, you invest in the eighty one market with a basic assumption that you are senior to equity. So if anything wrong goes happens to the bank, you would expect story shareholders to first of all burn through entirely down to the last cent, and then be touched. And now Credit Swiss, obviously they had tens of billions of dollars in CT one capitalized. It's called that that's common equity pretty much, and you could be rather safe

that nothing was going to happen to you. Now, there was a very rare trading session happening on Sunday, extraordinarily among bond holders and bond trading desks, especially in the US.

And when the news came out that Ubas is going to pay something, or shareholders at least anything, this is when you saw the prices of those bonds shooting up because nobody could fathom the fact that they could take any loss, even of one cent if shareholders are getting something and this is what happened was a total shock afterwards. So did that whole market collapse? I mean, if if the credit Swiss at one bonds are worth nothing, it

doesn't mean all eighty ones are worth nothing. This is what started happening on Monday morning when markets reopened in Asia and Europe, and you saw the prices of these bonds just collapse in historic terms where we're talking about like prize drops of more than ten points. You never

see that whatever happens in the past. So there was a really serious fear that the one capital instrument that we had since the global financial crisis that we thought we could rely on is becoming worthless and that could have really serious repercussions for the global banking market. Really, but this is when you had regulators, for example, the European Central Bank in the Bank of England coming out to say, what the Swiss did, It's not something we

will do if we are ever in their position. They wanted to calm the market, and somehow they managed to stave off at least in the immediate crisis. So it's true that different countries, different regulators will treat these bonds differently in the event of a collapse of a bank.

Is that right? That is correct, But the problem is that you thought you had a certain degree of certainty in the past that at least everyone is going to follow the same rules, and this is not what happened with Switzerland, and this is why people were rather concerned about whether they can trust any authority really across the major banking jurisdictions. So given that is this is still still a viable market, you know, do we think that

this market survives? Broadly speaking, it should because well, frankly speaking, there's no alternatives right now. You can't just move to a different type of capital instrument because there's no regulation that allows you to do so. For now, what investors are doing they are pretty much blacklisting Swiss banks. They have created what's what's called the premium, a yield premium for Swiss banks. So if a Swiss bank would want to issue another additional tier one that will have to

pay up quite a lot. At this stage they can't possibly issue that. Nobody will want to buy that. But at least in the secondary market you see a large price gap between Swiss eighty ones and eighty ones from other restrictions and that will most likely remain the case for the forsueable future. Do you expect litigation as well? Oh yes, I mean lawyers have already smelled blood in

the water. There was already some calls to day by some large legal firms trying to drop up interest because at this stage eighty one bond holders have absolutely nothing to lose, and if anything, they have a lot of game because they believe that the lawyers on their side.

There was even a presentation by Credit Swiss on March the fourteen, that's like five days before they collapsed, before these eighty ones were written down, that said that you guys are senior to shareholders and that is they're in black and white. So these bondholders believe they have the law on their sides. They do have already some law firms that are willing to represent them, so just a

matter of time. Well, they're broader credit market implications from this and that the investors in the riskiest types of bonds are getting pretty badly burned here, does that make

them more risk averse? That cuts off funding to other companies and borrowers that need to get funding right now, That is true and that's going to have a very bad, very bad repercussions for the bank lending market, because if your cost of capital is increasing in general, then you're going to be you're going to be tightening your own

lending standards. This is something that a number of people have mentioned as a potential risk because it means that it's like several bank hikes by central banks, for example, happening all at once in one day. Because eighty ones used to be a cheap way of having up your balance sheets and then being able to lend onto corporate clients, normal people. If that's becoming much more expensive, then you have to tighten your lending standards. That's going to have

a second effect impact on put much. To be comma, I've got to ask on the point that you know, invest want to litigate here. It was pretty clear from the paperwork. Maybe it's very deep on page one hundred and fifty of the perspectives, but it was clear that this is what this is what would happen in the event of a collapse, and it was also apparently on the Swiss regulators website. I mean, this is information that was available. Why is everyone surprised now and why they

why do they think they've got a chance to litigate. Well, I'm not going to go into the legal details. Also because a number of people who are bit unclear about that this was a risk factor and not a m Some of the detractors would say, some of the people who wanted to litigate, what that means is that you were just being told what may happen in case, you know, a resolution or any other intervention had to take place,

didn't tell you what will definitely happen. So they believe there's the belief that because that was just a risk factor, they can litigate against that. And also, yes, that was a fine print, the larger print, as I mentioned before the presentation that came out a few days before the collapse, that was actually quite unequivocal as well. At the end of the day, though bondholder is not lawmakers, lawmakers are

actual lawmakers. And what they did was they tweaked the rules in the weekend in order to allow a shotgun marriage to happen. And I guess you have good ahead with that or just trying to see the government and that's going to be a rather difficult proposition. So before we talk to Jody Lurie at Bloomberg Intelligence about the impact that the banking cresis is having on US companies, and you know all of that call out, what's the

big takeaway for you here, Teslas? It may be too soon to say because we're still kind of in the eye of the storm. But what are the lessons learned? Is it simply another case of by everywhere for credit markets investors need to read the small print or is there something more nuanced and sophisticated we can pull from the wreckage right now? Well, the problem with a two ones so eighty ones became very popular among European investors

during the era of zero interest rates. So when you were getting nothing or even negative interest rates on senior bonds, these junior bonds were paying you six seven, eight nine percent, so you wanted to believe that there isn't going to be any negative avecome from that. You just even get the bonds, get the nine percent coople every year and hopefully get called five years time. What it means got out of it is that, first of all, as you said before, everyone needs to read the fine print, even

if it is a risk factor. Take it seriously. When you see a ten percent Cooper Normalscent Coopers credit risk issued last year. Well, you have to think that it comes with a certain risk. You don't just get it for free. And whenever a band goes into trouble, just think of the seniority ladder, even a two ones. Yes, I know that they're seeing into equity, but when it comes to death, they were like rock bottom. So if anything goes wrong, chances are you can be here as well.

Prot Us from Bloomberg News, thanks so much for joining us. This is a really fascinating story with broad implications, and we look forward to reading all of your scoops on the Bloomberg terminal and of course at Bloomberg dot com. Thank you. Switching gears here a bit. As I mentioned earlier, we're very fortunate to have Jody Lewie from Bloomberg Intelligence. You get to cover all the fun stuff. Thanks for being on the show. Thank you for having me, James,

I'm so excited to be here. The companies you look at, let's talk about how they're acted by what's going on in the banking sector. I mean, it's not just credit sweets. As TESSAs mentioned, several regional banks also blew up over the last few weeks. That doesn't help at all. How's

this crisis playing out? Sure, So, just for an aside, I mean the process of reading Treasury Gitner's book on stress testing and on the two thousand and eight events, and it's interesting to listen to Tassos and the parallels of words that he's using that were words that we

used as everyday jargon in two thousand and eight. And I think the clear issue here is the question of whether this issue with credit sweets as well as the regional banks becomes more of a lack of a better word, contagent for the general market if it reaches from Wall Street to Main Street, and what that echo effect has on sectors like mine where it's more directly associated with consumers and what consumers like to do when they feel

more comfortable in the economy. These companies U cover. I mean, we should probably talk about which companies and which sectors a bit more detail. But they are seeing a big revival in demand as people get back to what they were doing before the pandemic. And at the same time, a lot of them have a ton of debt that got suddenly got a lot more expensive to refinance into services as rates jumped. What sectors and companies are the

most exposed to a list and why? Sure, James, So I think I think we need to take a step back and think about two thousand and twenty. So in two thousand and twenty, the companies in my sect sector, so we're talking the cruise lines, we're talking the theme parks, we're talking the hotels and the restaurants, they issued eighty five billion in two thousand and twenty in debt alone in the US markets. You compare that two and twenty one and it was forty nine billion, and then in

twenty twenty two is thirty six billion. So these are large scale amounts as compared to pre pandemic levels that were only small margins of what we saw in two thousand and twenty and onward. So these companies have been pretty dependent on the capital markets to help finance their operations while people have sort of backed off from what

they normally do. As we've seen people return to normalcy, we've seen fewer and fewer companies come to market because they're able to finance their operations with cash flows, as

companies should do. But you take the cruise lines, for example, they're still heavily dependent on the capital markets to fill in cash gaps, as they get more people on the ships, as they get back to normalcy, as they start generating cash flow, and I think we're probably a year out before these companies feel really comfortable with their operational standpoint to finance their business without use of the capital markets.

But they all said, you said they'd borrowed a ton during you know, when they really needed the money, and that money eventually comes to you. Are they building themselves into a massive putting to a massive problem with the maturity will eventually? So the maturity wall is definitely a question that we have. In twenty twenty four and two twenty five, you see a large spike in maturities, particularly the high yield market, particularly in the consumer discretionary area,

which is where my companies fall. And a lot of the companies have already started tapping the debt markets before the SVB and credit suites fallout, so a lot of them have locked in financing in advance of this. However, we are seeing that there's probably a separation between the companies that are in good standing and the companies that are still a little bit more in the transitional period.

By that, I mean you take a company in like Marriott, and they've already repaid all of their debt that they borrowed during the pandemic, So they they took down their whole entire credit line. Now they've repaid it, they brought themselves back to pre pandemic credit ratings of triple B flat, and they've tapped the capital market the excuse me, the commercial paper markets in order to anancer business. And you hear commercial paper markets, you get concerned because it's short

term financing. However, when a company reaches a certain credit quality, when a company is in good standing and they feel comfortable, they feel comfortable using the commercial paper markets as opposed to using something like their longer term vehicle like a revolver, to finance any sort of cash gaps that they have. So you take a company like Marriott, you pair that with a company like Carnival Cruise Lines that has thirty

five thirty six billion of debt outstanding. They've paired back their short term debt maturities significantly, but they still have thirty three billion in long term debt outstanding that they'll need to address over the next few years. Right, So the ones that are most exposed other than cruise lines,

who are you most worried about him? So, I think when we think about any sort of contagion risk or any sort of broader sort of market eco effects, I think you have a couple of different areas that you

could see this as problematic. Firsus the casinos. If we talk more broadly of a recession, which has been a discussion point since the beginning of this year, you could definitely see the casinos feeling a little bit stretched or a little bit pressured by lack of financing, lack of market liquidity, lack of the ability to access the capital markets, as well as consumers pulling back on their on their spending.

Separate from that, a sort of niche area that we've been trying monitor is the relationships that things like hotels have with their counterparties. And by that we mean the reets, we mean the hotel owners and franchisees. Those are the companies that might be caught off guard by regional bank issues that you might not necessarily see otherwise with such

large companies. Similarly, you might see something happen with companies such as McDonald's that rely so heavily on the franchise business, so their franchisees depend on regional banks more so than you'd see at these large scale companies that work with the largest investment banks out there. Okay, and the winners other than are there any other companies that are in good shapes to kind of withstand all these pressures that we're seeing right now. So I think you have to

think about it from a standpoint of brand. I think you have to think about it from a standpoint of companies that have really put themselves in good standing. The theme parks that have been doing pretty well over the past year year and a half, and that's because people have been wanting to go and do and the companies have taken advantage of that by bringing down their debtload

having cash put away. They have been spending their cash on shareholders, but I think that they'd probably opt to squirrel away some cash if they thought that it weren't

so easy to do that. If you look at the rental card companies, they're an interesting sort of situation because they have a combination of better credit quality, lower leverage, but they also have created an exposure for themselves by way of risk vehicles and by that we mean those are the vehicles that they're buying outright that they're going to have to offload themselves, as opposed to the program vehicles that they can give back to the autos. So

I think there's pockets of opportunity. I think it's really a question of company by company basis. If you look at something that Kilton, they've been doing very well for themselves, but they also don't care to bring down their debtload as much as Marriott does. So you have these sort of opportunities both in high yield and in investment grade.

And I think it's really a question of individual companies and also managements policies towards ratcheting in or bringing in any sort of shareholder spending that they're doing, as well as being a little bit more prudent on capex if times get tough, if purse strings get get a little tighter. So we came into this year and everyone was talking about the Year of the bond, because last year was

so terrible for the fixed income. Everyone was really excited about these sectors that got so beaten up, including these consumer sectors that we're talking about here. The bonds have rallied quite a lot in the first two months of the year. Obviously the banking crisis didn't help, but there's still pretty tight you know, based on history, is the risk all these risks? Are they properly priced in right now? You're thinking too credit monkeys. I think you have two

sides of the coin at the moment, James. I think on the one side, you have consumers that are still very much spending. Consumers want to spend, and they're not spending on goods, they're spending on services. So that's a really good thing for my sector. That means that people who have been stuck inside, who are tired of looking at their same house and now office as they return to the office, want to go and do. They want to go on lavish vacations. They want to go on cruises.

They want to do things that they didn't feel comfortable doing before we had vaccines, before we made COVID A sort of common problem. Not that people don't really appreciate getting COVID at this point as much as they didn't appreciate it a year ago. But I think people are just fatigued by the general sentiment of a pandemic, and so people are going and doing, and we're seeing that in the data. Still, we're seeing that people are still

wanting to go and do. So that's a really positive situation. Now, the other side of the coin is in the event of a recession, or in the event of an uptick and unemployment rate, in a situation where we have runaway inflation, or a situation where we have just a pullback in general of people saying, Okay, I don't really know what's going on with these banks. I don't really know what's going on with my own personal savings situation and my

own personal spending account. So I'm gonna stop spending on these lab vish vacations. And I think that's where you sort of see the problem. Similarly, businesses and business spending and conferences have started to really boom recently, and if we if we see that cut short, that could be problematic form my area. So I'm a credit guy, which generally means I'm pretty pretty negative, you know, pretty pessimistic.

Sorry for that, but you know, you mentioned contagion, and just just to end, not to end on a loan note, but but after so many years of easy money and cheap borrowing, and you know, money slashing around the system. Suddenly it's getting a lot more expensive. Suddenly the consumers under a lot more pressure because of inflation. You know, there are so many to me, you know, potential negatives out there. Should we expect a lot more distress and

defaults or does this all blow over? So I think that that the default situation is always that's always a problem. And you, like me, James, I'm always looking at the boogeyman over my shoulder, and I always sort of wonder what the next shooter drop is. Not to mix metaphors, but I will say that that on the one hand, I'm optimistic about my my sector, which you know I always called pause too. But I think that really, when you're talking about financing, it's been expensive for my sector,

you know, for over a year now. I mean you look at some of the cruise lines and they had to issue double digit bonds a year ago to finance their operations. And so I don't necessar necessarily think that right now is going to be different than what they've already been faced with for a year now that they've already had to digest. I think the bigger question is if there's a massive pullback in market liquidity, meaning the ability for companies to access the capital markets. What does

that mean for these companies? Will they have to get creative in other ways? Will we start seeing a large segments of their business, the non core portion of their business gets sold off. We already saw with the casinos that they got creative to increase their liquidity as they're waiting for things like China to open up again, so that Macau was operational, and so what we saw was things like sale leasebacks, meaning they sold off their actual

property and now they're just the property manager. We saw that with the hotels as well, that a lot of them are asset light, which is a little bit worrisome when you think about it from a standpoint of if they needed to get creative with their balanchies, how would

they do that. I mean, the brand is only worth so much, So we are constantly viewing this as a what's next and what could these companies do to get creative to sort of fill in any cash gaps in the event of a significant market pullback and the inability for companies to finance operations. Let's hope you're right on the sunnier outlook that I have very important to keep on top of those sectors. Very important to keep on top of those sectors right now, not just for those

who like going on cruises. Thank you, Jody sure Thing. Read all Josie's and Jody's analysis on the Bloomberg Terminal. Thank you very much, Jody Lourie at Bloomberg Intelligence. I look forward to catching up again very soon. And thanks again to Tassos Bossels from Bloomberg News. Read all of his scoops on the terminal and at Bloomberg dot Com. Keep an eye on the bank story right now. No matter what part of the market you're in, Tassos and his team will continue to break a lot of news

about that incoming weeks. I'm James Crombie. It's been a pleasure having you. See you next week on the Credit Edge.