Hedge Funds That Bet on Credit Suisse Rescue Face Uneven Results

As the value of Credit Suisse stocks and bonds plummeted last week, some investors viewed the sell-off as an opportunity to buy, anticipating that regulators would step in and prevent Credit Suisse from total collapse. They were right.

Swiss regulators approved a deal for the bank to be bought by its domestic rival UBS, though the hedge funds that swooped in to buy those beaten-up bonds from the storied Swiss bank face mixed results.

Among the funds to bet on the rescue deal were two that specialize in buying the bonds of companies on the brink of bankruptcy, according to two people with direct knowledge of the funds’ trades: Redwood Capital Management, which was a bondholder of the bankrupt Chinese real estate business Evergrande, and 140 Summer. Goldman Sachs, Jefferies and Morgan Stanley were among the banks facilitating the trades between investors.

Both 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’s bonds rose sharply at the end of last week as strain in the banking sector mounted, according to official trade data.

There were two types of trades that the investors conducted: one that is set to make money, the other that is set to lose money.

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

Because of the risks involved, the banks quoted prices to buy and sell that were unusually far apart, protecting them from sharp changes in prices. This also set up the banks to make more profit between the price they paid for the bonds and the price at which they sold them.

The second trade that investors plowed into was in Credit Suisse’s roughly $17 billion of so-called AT1 bonds. This is a special type of debt issued by banks that can be converted to equity capital should they run into trouble. This made that debt inherently riskier to hold, because it carried the chance that bondholders could be wiped out. Investors saw the buying of the bonds for as low as 20 cents on the dollar as a kind of lottery ticket — a long shot, but with a big reward if it had worked out.

Credit Suisse came under severe pressure last week as turmoil from the failure of California-based Silicon Valley Bank spread 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 stability for the bank’s customers and for the financial center,” said a statement from Finma.

It said that the AT1 bonds would be wiped out as part of the deal, to add roughly $16 billion of equity to support UBS’s takeover.

That raised eyebrows among some investors because it upended the normal order in which holders of different assets of a company expect to be paid in bankruptcy. Stock investors are at the bottom of that repayment list and usually lose all their money ahead of other investors.

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

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

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