What Are AT1 Bonds And Why Are Credit Suisse’s Depleted?

Financial markets have now been thrown a new curve ball by a decision to write down 16 billion Swiss francs ($17.5 billion) of Credit Suisse bonds, known as Additional Tier 1 or AT1 debt, to zero as part of a compelled rescue merger with UBS.

Under this deal, holders of Credit Suisse AT1 bonds will get nothing, while the shareholders, who normally rank below the bondholders in terms of who gets paid when a bank or firm collapses, will get $3.23 billion.

This news has hurt AT1 bonds that were issued by other European banks and they were faced with new selling pressure on March 24.

Here are various implications of the Credit Suisse AT1 bond write-down.

What Is An AT1 Bond?

AT1 binds – a $275 billion industry also known as “contingent convertibles” or “CoCo” bonds – work as shock absorbers in case a bank’s capital levels drop below a certain threshold. They can be changed into equity or written off.

They make up part of the capital cushion that the watchdogs need banks to hold to offer support in times of market turmoil. They are the riskiest kinds of bonds a bank can issue and so carry a higher coupon.

If AT1s are changed into equity, this supports a bank’s balance sheet and enables it to stay afloat. They also pave the way for a ‘bail-in’, or a way for the banks to transfer risks to investors and away from the taxpayers in case they get into trouble.

What Happened To Credit Suisse AT1s?

AT1s rank higher than shares in the capital structure of a bank. In case a bank runs into trouble, bondholders rank above shareholders in terms of getting their money back.

In Switzerland, the bonds’ terms state, nonetheless, that in a restructuring, the financial regulator is under no obligation to adhere to the traditional capital structure, which is how the bondholders lost out in the Credit Suisse scenario.

Credit Suisse AT1 holders, thus, are the only ones not to get any form of compensation. Under this rescue deal, they rank lower than the shareholders in the bank, who can at least get UBS’ takeover price of 0.76 Swiss francs ($0.8191) per share.

Who Ranks Higher?

European regulators stated on March 20 they would continue to impose losses on the shareholders before the bondholders.

Separately, the Bank of England also stated that Britain had a clear statutory order where shareholders and creditors of failed banks bear losses, with AT1 instruments ranking ahead of other equity instruments and behind tier-two bonds in the hierarchy.

Singapore and Hong Kong’s central banks stated on March 22 that they would stick to the traditional hierarchy of creditor claims in case a bank was to collapse in their jurisdictions.

It is not the first time that the treatment of AT1 bonds in a bank overhaul has caused lots of controversies. A dispute over the write-off of nearly $1 billion of AT1 bonds issued by India’s Yes Bank in March 2020 after the Reserve Bank of India initiated a strict restructuring of the lender is now subject to Court proceedings.

What Does This Mean For Investors?

Fixed-income investors got shocked by the write-down of Credit Suisse’s AT1 debt to zero. One bank adviser and a bond investor stated that the Swiss government’s actions were legal because the kind of AT1 bonds issued by Credit Suisse might be subject to an entire write-down.

However, the price of other banks’ AT1 bonds has plunged as the investors have panicked, fearing their bonds, which were mostly meant to offer extra protection than shares, might eventually face the same fate.

For now, Credit Suisse’s AT1 bondholders are seeking legal advice.

What This Means For the General Market

The decision to write down Credit Suisse AT1 bonds to zero is seen as negative for the AT1 bond market globally.

Standard Chartered Chief Executive Bill Winters stated that the move had extensive implications for global bank regulations.

Bid prices on AT1 bonds from banks, including HSBC, UBS, Deutsche Bank, and BNP Paribas plunged this week, sending yields steeply higher, according to data from Tradeweb.

Germany’s Deutsche Pfandbriefbank stated that it will not redeem its 300 million euro AT1 bond when a call option expires on April 28, while Aereal Bank said it was unlikely to call its bond though a final decision was yet to be taken.