By John O'Donnell and Chiara Elisei
FRANKFURT/LONDON (Reuters) - Swiss authorities are examining imposing losses on Credit Suisse bondholders as part of a rescue of the bank, two sources with knowledge of the matter said on Sunday.
However, European regulators are apprehensive about such a move for fear that it could hit investor confidence elsewhere in Europe's financial sector, the sources said, speaking on the condition of anonymity.
A final decision, however, had not been taken and the terms could still change, according to the sources.
Losses on bondholders may need to be larger if Credit Suisse were wound down rather than if it were taken over by UBS, one of the sources said. Authorities are trying to engineer a UBS takeover of Credit Suisse before financial markets reopen on Monday.
FINMA, the Swiss regulator, did not immediately respond to a request for comment. Credit Suisse and UBS declined to comment.
Despite the prospect of losses, some bond investors on Sunday were encouraged by a report in the Financial Times that UBS had offered up to $1 billion to buy its rival, although there is no guarantee a deal with UBS will be reached.
The price of one of Credit Suisse's Additional Tier 1 (AT1) bonds, a junior tranche of debt which slumped in price this week, rallied in limited trading after the report, one investor said.
A $1 billion deal would mean Credit Suisse shareholders getting a fraction of what their shares were worth on Friday.
But with bonds sitting above equity in the priority ladder for repayment in a bankruptcy process, two investors said it would be unlikely bondholders would take a hit if shareholders get something.
"I would be surprised if Credit Suisse bondholders, including AT1 investors, weren’t made whole. As long as UBS pays something to equity investors, bondholders should be left untouched," Jerome Legras, head of research at Axiom Alternative Investments, an investor in Credit Suisse’s AT1 debt, told Reuters.
AT1 bonds are designed to turn into equity if a bank's capital is depleted to help prop up the bank.
Another holder of the debt said they expected the AT1 bonds could be converted into UBS shares if a deal went through.
Credit Suisse bonds plunged into distressed territory at or below 30 cents on the dollar this week as investors worried about the health of the bank even after the Swiss National Bank provided the lender with a $54 billion emergency loan.
Protecting bondholders from losses would boost confidence across the financial industry, but a deal with UBS is just one potential outcome. If the takeover falls apart, Switzerland is considering taking over the bank in full or holding a significant equity stake, Bloomberg reported.