Additional Tier 1 Bond Wipeout Gives a Wakeup Call for Investors and Fund Managers on Their Riskiness
Moneylife Digital Team 25 March 2023
On 19 March 2023, the Swiss national bank announced that UBS will buy the crisis-hit Credit Suisse for US$3.3bn (billion). The historic government-engineered deal came through as UBS struck the deal to buy Credit Suisse in a share deal that imposed 89% losses on the Credit Suisse shareholders. 
The holders of Credit Suisse's US$17bn in 'additional tier one' (AT1) bonds have been in a state of turmoil since the Swiss government announced that the AT1 bonds would become worthless. Even while equity shareholders of the Bank are apparently slated to receive one UBS share for every 22.48 Credit Suisse shares they currently possess, the high-risk bond will be wiped down. 
Although equity investors are typically expected to bear the losses before bond-holders due to the seniority of the capital structure, the writing down of AT1 notes has not been well-received by the bond-holders. Interestingly in a recent presentation to its investors, Credit Suisse said that in the event that the Bank went through a resolution procedure, shareholders would be hurt harder than AT1-holders.
The write-down by Credit Suisse is the greatest setback in the history of the AT1 market in Europe, which is estimated to be worth US$275bn. When Banco Popular was acquired by Bank Santander for €1 to prevent its collapse in 2017, US$1.44bn worth of AT1 notes were written off in Spain. 
The high-risk AT1 bonds have been in the headlines in India in a confounding and comparable situation ever since Yes Bank chose to write-off AT1 notes worth around Rs8,400 crore as part of its restructuring strategy. The Bombay High Court overturned that ruling, nevertheless, and a case against it is still pending before the Supreme Court. 
Currently, as evidenced by the Yes Bank and Credit Suisse instances, it doesn't take much for the AT1 bonds to lose all of their value during a crisis. It's also intriguing to watch if Credit Suisse's writing down of AT1 bonds will be cited in Yes Bank's defence when it next goes before the Supreme Court.
Due to the provision that banks may stop making interest payments on AT1 bonds or even write them off in the event of a financial emergency, these bonds are regarded as high-risk debt instruments. They are a desirable option for investors since they provide higher returns than other debt papers in stable conditions. The type of debt known as AT1 bonds, commonly referred to as contingent convertibles or "CoCos," is seen as being a component of a bank's regulatory capital. In some circumstances, such as when a bank's capital ratio drops below a predetermined threshold, holders may convert them into equity or write them down.
After the financial crisis, AT1s were developed as a means of transferring risks from taxpayers to other parties in times of need. They frequently have greater yields than ordinary bonds because of their increased risk.
The fact that UBS group AG is more dependent than any other large bank in Europe on the hazardous AT1 bonds that were wiped out in the Credit Suisse takeover is intriguing. AT1 bonds are equivalent to around 28% of the highest quality regulatory capital held by UBS, according to a Bloomberg report. While the 16 largest banks in Europe have an average exposure of roughly 16%. The Bloomberg report also states that, aside from Credit Suisse and UBS, no other major banks have provisions that would permit the full write-down of this kind of bond.
The regulators took a different approach in a similar tale that played out in the US. The Federal Deposit Insurance Corporation (FDIC), which has been tasked with managing bank failures, first closed the troubled Signature Bank.Then, all of Signature Bank's deposits and assets were transferred to Signature Bridge Bank NA as a temporary bridge bank. The plan was to liquidate the Bank, sell off the assets, or find a buyer. A portion of the assets of Signature Bank were sold by the FDIC to New York Community BankCorp.
As of December 2022, the formerly known as Signature Bank had total assets of US$110.4bn and deposits totaling US$88.6bn. A bridge bank is required by FDIC rules to hold the bankrupt bank's assets and liabilities until a buyer is located or the assets are sold. According to the terms of the agreement, the current transaction to New York Community BankCorp includes US$18bn in assets from Signature Bridge Bank as well as a US$12.9bn loan book that was sold at a discount of around US$2.7bn. The Bank has over 110 billion dollars worth of assets in total. The US$60bn in loans will continue to be in receivership. The US regulator has a maximum of three years to dispose the remaining loan assets.
Kamal Garg
1 year ago
It is definitely a legally untenable and controversial decision taken by UBS/Credit Suisse.
By the way, European Central Bank has categorically stated that in such similar situation, it would first write-off common equity and then would write-off AT-1 bonds. And since Switzerland is not part of the EU banking system, therefore, it could adopt a different resolution and took the shelter of UBS/CS provisions.
Everywhere, including in India, it is very clear that AT-1 bonds are quasi-equity and "can be written-off in the event of bank not able to meet its obligation subject to that the common equity has been fully written-off". AT-1 bonds cannot be written-off before the common equity is written off.
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