LONDON/NEW YORK, March 19 (Reuters) - Credit Suisse said 16 billion Swiss francs ($17.24 billion) of its Additional Tier 1 debt will be written down to zero on the orders of the Swiss regulator as part of its rescue merger with UBS (UBSG.S), angering bondholders on Sunday.
FINMA, the Swiss regulator, said the decision would bolster the bank's capital. The move reflects authorities' desire to see private investors share the pain from Credit Suisse's troubles.
Chair Marlene Amstad said FINMA had stuck to the country's "too-big-to-fail" banking framework in making the decision.
It means AT1 bondholders appear to be left with nothing while shareholders, who sit below bonds in the priority ladder for repayment in a bankruptcy process, will receive $3.23 billion under the UBS deal.
Engineered in the wake of the global financial crisis, AT1 bonds are a form of junior debt that counts towards banks' regulatory capital. They were designed as a way to transfer risks to investors and away from taxpayers if a bank gets into trouble.
The bonds can be converted into equity or written down when a lender's capital buffers are eroded beyond a certain threshold.
"It's stunning and hard to understand how they can reverse the hierarchy between AT1 holders and shareholders," said Jerome Legras, head of research at Axiom Alternative Investments, an investor in Credit Suisse's AT1 debt.
Reuters reported earlier on Sunday that Swiss authorities were considering imposing losses on bondholders as part of the rescue deal.
UBS' CEO Ralph Hamers told analysts that the decision to write down the AT1 bonds to zero was taken by FINMA, so it would not create a liability for the bank.
Credit Suisse's AT1 debt had rallied earlier on Sunday amid reports that shareholders would receive something in a deal with UBS, raising hopes that bondholders would be protected.
The bonds had sunk into distressed territory before the weekend due to mounting concerns over the health of the Swiss lender.
The move by the Swiss regulator could make it harder for other lenders to raise new AT1 debt, investors said.
"It's going to make the AT1 bonds more expensive for all the other banks going forward, because now everyone else is going to see this extra risk," said Michael Ashley Schulman, partner and chief investment officer at Running Point Capital Advisors.
AT1s pay higher interest as they carry more risk for investors than regular debt.
Prior to Sunday's news, investors had been apprehensive about the prospect of banks extending outstanding AT1 bonds to avoid refinancing at worse terms because of higher interest rates.