Holders of Credit Suisse Group AG bonds suffered a historic loss when a takeover by UBS Group AG wiped out about 16 billion Swiss francs ($17.3 billion) worth of risky notes.

The deal will trigger a “complete write-down” of the bank’s additional tier 1 bonds in order to increase core capital, Swiss financial regulator FINMA said in a statement on its website. Meanwhile, the bank’s shareholders are set to receive 3 billion francs.

The bond wipe out is the biggest loss yet for Europe’s $275 billion AT1 market, far eclipsing the only other write-down to date of this type of security: a €1.35 billion ($1.44 billion) loss suffered by junior bondholders of Spanish lender Banco Popular SA back in 2017, when it was absorbed by Banco Santander SA for one euro to avoid a collapse. In that instance, the equity was also written off.

In a typical writedown scenario, shareholders are the first to take a hit before AT1 bonds face losses, as Credit Suisse also guided in a presentation to investors earlier this week. That’s why the decision to write down the bank’s riskiest debt — rather than its shareholders — provoked a furious response from some of Credit Suisse’s AT1 bondholders.

“This just makes no sense,” said Patrik Kauffmann, a portfolio manager at Aquila Asset Management AG. “This will be a total blow to the AT1 market. You can quote me on that.”

Kauffmann believes that money should have gone to AT1 holders instead, leaving nothing for shareholders, as “seniority in the capital structure need to be respected.”

AT1 bondholders

Pacific Investment Management Co., Invesco Ltd. and BlueBay Funds Management Co. SA were among the many asset managers holding Credit Suisse AT1 notes, according to data compiled by Bloomberg. Their holdings may have changed or been sold entirely since their last regulatory filings.

Pimco and BlueBay declined to comment when contacted by Bloomberg News on March 17, before the deal was announced. A spokeswoman for Invesco said that its investment teams are continuing to monitor developments.

AT1 bonds were introduced in Europe after the global financial crisis to serve as shock absorbers when banks start to fail. They are designed to impose permanent losses on bondholders or be converted into equity if a bank’s capital ratios fall below a predetermined level, effectively propping up its balance sheet and allowing it to stay in business.

Prices on those bonds fluctuated wildly as traders gathered for a rare weekend session on March 19 to weigh two scenarios: either the regulator would nationalize part or the whole bank, possibly writing off Credit Suisse’s AT1 bonds entirely, or a UBS buyout with potentially no losses for bondholders.

Prices oscillated between 20 cents on the dollar to as high as 70 cents when the deal was finalized. Following the FINMA announcement, some trading desks simply updated their clients that a write-down had occurred.

The broader market for those risky European bank bonds, also known as contingent convertibles or CoCos, has also tumbled in the past two weeks, with the average AT1 indicated at a price of about 80% of face value on March 17, one of the steepest discounts on record.

Hand grenades

For some investors, the fact the UBS deal rendered the notes worthless came as no surprise, given their well-known downsides.

Holders of AT1s knew they were buying high-yield risk with a hand grenade attached to it, according to John McClain, portfolio manager at Brandywine Global Investment Management.

“It’s absolutely the right thing to do to prevent moral hazard from creeping into that part of the market,” he said. “Those bonds were created for moments like this. Similar to catastrophe bonds.”