A Credit Suisse bank sign on a branch constructing in Geneva, March 15, 2023.
Fabrice Coffrini | AFP | Getty’s paintings
Within the aftermath of UBS’s takeover of Credit Suisse, many investors lost out.
But one group specifically felt left behind after their investments: AT1 bondholders, who saw their 16 billion Swiss francs ($17 billion) value of assets worn out.
AT1 bonds can be written to zero under a deal between Credit Suisse and UBS, Swiss regulator FINMA said on Sunday. The move was quite unusual, prompting investors to threaten legal motion and other financial authorities across Europe to distance themselves from FINMA.
But what are AT1 bonds, why do they matter and what happens next?
Additional Tier 1 Bonds, AT1, CoCo?
AT1 Bonds is brief for Additional Tier One Bonds. Briefly, these are bank bonds that are considered a comparatively dangerous type of subordinated debt and subsequently have the next yield and are often purchased by institutional investors.
They are also sometimes known as contingent convertible papers or “CoCos”. The name comes from the power to convert them into equity or redeem them, so reduce their value to zero – but only in certain scenarios.
This is usually related to the capital ratio of the bank that issued the bonds. If, for instance, it drops below a certain level, a contingency plan for investors converting their shares becomes an option.
AT1 origin story
AT1 bonds stem from the aftermath of the 2008 financial crisis, when regulators tried to shift risk away from taxpayers and increase capital held by financial institutions to guard them from future crises.
At the moment, regulators in Europe established a framework that defined capital ratios, which is the balance between assets comparable to equity investments, AT1 and other more senior debt. This can also be the order through which they are to be prioritized based on the framework.
Nonetheless, within the case of Credit Suisse, investments of AT1 holders have been redeemed, while odd shareholders are expected to receive a payout from the transaction.
In a research note, Goldman Sachs credit strategists said “this might be interpreted as effectively subordinating AT1 bondholders to shareholders”, making the move unusual.
These bonds offered higher yields than many comparable assets, in some cases near 10%, reflecting the inherent risk taken by investors. A Credit Suisse AT1 prospectus, seen by CNBC, suggests that shareholders may take precedence over these bondholders – but especially within the event of a bank failure. But bondholders query whether the bank needs to be declared “failed” in the standard sense – a case that may likely find yourself in court.
Carl Weinberg, chief economist and managing director of High Frequency Economics, told CNBC’s Squawk Box Europe on Tuesday that regulators are there to guard depositors and the system is working because it should.
“While I feel bad for all those CoCos and AT1s losing money… that is what the system was designed for,” he said. “It’s an ideal example of regulation.”
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How they work and why they are dangerous
One among the important thing features of AT1 bonds is that they are designed to soak up losses. This happens routinely when the capital ratio falls below a pre-agreed threshold and the AT1s are converted to equity.
Larger banks, nevertheless, often have a major buffer as a result of capital ratio requirements, so such an consequence is rare – the acquisition of Credit Suisse was the primary major test for AT1.
This can also be where one among the important risks is available in – if the mechanism is triggered, bondholders could lose their investment entirely or find yourself with equity stakes in a weakened bank.
An extra factor influencing the increased risk are the powers of regulators, who may, for instance, limit payments on the annual rate of interest on bonds, including AT1 bonds.
Finally, AT1 bonds may be redeemed relatively than maturing at a particular cut-off date. Normally, banks call and reissue them inside a certain time period, but when they don’t, investors are stuck with them for longer.
What’s next for AT1 in Europe
Various EU regulators have distanced themselves from FINMA’s decision to destroy the worth of Credit Suisse’s AT1 bondholders. Switzerland just isn’t a part of the European Union, so it just isn’t subject to the bloc’s regulations. Nonetheless, some damage could have already been done and could affect broader investor sentiment.
“European regulators and central bankers are now attempting to restore confidence within the AT1 bond market, which now poses a serious threat to any extension of investor sentiment recovery within the region,” ING strategists wrote in a memo published on Tuesday.
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On Monday, Elisabeth Rudman, global head of economic institutions at DBRS Morningstar, told CNBC:Squawk Box Europe” that AT1 bonds in other banks were also in danger.
“There are risks with prices and the best way investors, perhaps some investors, re-evaluate the profit they are in search of,” she said.
Within the case of Credit Suisse, AT1 bondholders are considering taking legal motion, preparations are underway at law firms.