Credit Suisse: What are AT1 Bonds and Why They’re Making News
March 29, 2023
Global financial markets have been rattled by a new development, as 16 billion Swiss francs (US$17.5 billion) of Credit Suisse bonds, known as Additional Tier-1 (AT1) debt, have been written down to zero in a forced takeover by UBS.
In this arrangement, Credit Suisse AT1 bondholders will receive nothing. Meanwhile shareholders, who typically rank lower than bondholders in terms of payouts during a bank or company collapse, will be granted US$3.23 billion (the buyout price).
This announcement has negatively impacted AT1 bonds from other European banks, leading to increased selling pressure last Friday (24 March).
What is an AT1 Bond?
AT1 bonds, a market segment worth US$275 billion, are also referred to as “contingent convertibles” or “CoCo” bonds.
These instruments serve as financial shock absorbers when a bank’s capital levels dip below a specified limit, as they can then be converted into equity or written off.
These bonds constitute a portion of the capital buffer that regulatory authorities mandate banks to maintain for stability during market disruptions.
As the most hazardous type of bond a bank can issue, AT1 bonds offer higher coupon rates. If converted into equity, AT1 bonds fortify a bank’s balance sheet, aiding its survival.
Additionally, they facilitate a “bail-in” mechanism, allowing banks to shift risks to investors rather than burdening taxpayers in case of financial distress.
What happened to Credit Suisse’s AT1s?
AT1s have a higher ranking than stock within a bank’s capital structure, meaning that if a bank encounters difficulties, bondholders have priority over shareholders in reclaiming their funds.
In Switzerland, however, the bond agreements stipulate that during a restructuring, the financial regulatory authority is not required to follow the conventional capital structure.
That’s why bondholders experienced losses in the Credit Suisse case.
As a result, Credit Suisse AT1 holders are the only group not receiving any form of compensation.
In the bailout agreement, they are ranked below the bank’s shareholders, who are at least eligible for UBS’s acquisition price of 0.76 Swiss francs (US$0.8191) per share.
AT1 bond write-down shock investors
The unexpected devaluation of Credit Suisse’s AT1 debt to zero left fixed income investors astonished.
A bank consultant and a bond investor confirmed that the Swiss government’s decision was lawful, as the specific AT1 bonds issued by Credit Suisse could be fully written down.
However, the value of other banks’ AT1 bonds has declined due to investor anxiety, as they worry that their bonds, intended to offer greater security than stock, might suffer a similar outcome.
Credit Suisse’s AT1 bondholders are now pursuing legal counsel.
Aside from the legal matters, the decision to reduce Credit Suisse AT1 bonds to zero is seen as unfavourable for the global AT1 bond market.
This development has profound consequences for worldwide banking regulations, which could cause investors to exhibit increased caution when buying AT1 bonds in the future.
This complicates the process for banks that rely on bond markets to satisfy regulatory demands.
AT1 bond bid prices from institutions declined this week, causing yields to rise significantly.
Singapore banks remain strong
Investors who are worried if the development has any effect on the Singapore banks can take a breather.
The write-off, or conversion of Credit Suisse’s AT1 bonds, will not represent similar risks to Singapore banks given the strong corporate governance and risk management at Singapore banks.
United Overseas Bank Ltd (SGX: U11) does not have any holding in Credit Suisse’s AT1 holdings while DBS Group Holdings Ltd (SGX: D05) and Oversea-Chinese Banking Corporation (SGX: O39) said that their exposures are insignificant.
For banks in ASEAN, they are less affected by this event due to their smaller exposure to US and EU banks and corporations.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
Billy is passionate about the capital market and believes in investing for the long haul. Prior to this, he was an economist at RHB Investment Bank, covering Thailand and Philippines market. He also worked as a financial journalist at The Edge Malaysia and has experience working with an asset management firm. Aside from the capital market, Billy loves a good conversation over a cup of coffee, is a fitness enthusiast and a tech geek.