Hedge funds betting on Credit Suisse bailout face mixed results

As the value of Credit Suisse stocks and bonds fell last week, some investors viewed the selloff as a buying opportunity, anticipating that regulators would step in and prevent Credit Suisse from collapsing entirely. They were right.

Swiss regulators have approved a deal for the bank to be taken over by domestic rival UBS, although hedge funds that have rushed to buy these battered bonds from the famed Swiss bank are facing mixed results.

Among the funds to bet on the bailout deal, two specialized in buying bonds from companies on the verge of bankruptcy, according to two people with direct knowledge of the fund business: Redwood Capital Management, which was bankrupt Chinese bank bondholder Evergrande real estate company and 140 Summer. Goldman Sachs, Jefferies and Morgan Stanley were among the banks facilitating transactions between investors.

140 Summer and Redwood declined to comment. Goldman Sachs and Jefferies declined to comment. Morgan Stanley did not immediately respond to a request for comment.

Trading in Credit Suisse bonds rose sharply late last week as stress in the banking sector grew, according to official trade data.

Investors made two types of transactions: one intended to make money, the other intended to lose it.

The first is Credit Suisse regular bonds: debt that the bank has borrowed at a fixed interest rate to be repaid over a specified period of time. These bonds were trading at around 60 cents on the dollar at the end of last week, meaning anyone selling suffered a 40% loss to their original value. Traders said on Sunday some bonds had already risen sharply following the deal, now that the immediate threat of a Credit Suisse reneging on its debts had passed.

Due to the risks involved, the banks offered unusually wide buying and selling prices, thus protecting them from sharp price swings. It also allowed the banks to make more profit between the price they paid for the bonds and the price at which they sold them.

The second deal investors got into was for Credit Suisse’s roughly $17 billion in so-called AT1 bonds. This is a special type of debt issued by banks which can be converted into equity in the event of difficulties. This made such debt inherently riskier to hold, as it carried the risk that bondholders would be wiped out. Investors saw buying the bonds for as little as 20 cents on the dollar as a sort of lottery ticket – a long shot, but with a big reward if it worked.

Credit Suisse came under heavy pressure last week as turmoil over the bankruptcy of California-based Silicon Valley Bank spilled across the Atlantic.

On Sunday, the Swiss Financial Market Supervisory Authority, or Finma, approved a deal for UBS to take over its smaller rival. “The transaction and the measures taken will ensure the stability of the customers of the bank and the financial center”, indicates a press release from Finma.

He said AT1 bonds would be eliminated as part of the deal, to add about $16 billion in equity to support the UBS takeover.

This has raised eyebrows among some investors as it upsets the normal order in which holders of different assets in a company expect to be paid in the event of bankruptcy. Equity investors are at the bottom of this redemption list and usually lose all their money before other investors.

However, in this case, regulators chose to trigger the conversion of AT1 bonds into equity to help the bank, while offering Credit Suisse shareholders one UBS share for every 22.48 Credit Suisse shares held.

“This acquisition is attractive to UBS shareholders but, let’s be clear, as far as Credit Suisse is concerned, this is an emergency rescue,” said Colm Kelleher, chairman of UBS. “We have structured a transaction that will preserve the remaining value of the business while limiting our downside exposure.”