Credit Suisse's AT1 bond write-down highlights risks for investors

In Zurich are logos of Swiss banks UBS and Credit Suisse.

LONDON Reuters -- Just over $17 billion worth of Credit Suisse bonds, also known as Additional Tier 1 or AT 1, will be written down to zero on the orders of the Swiss regulator as part of a rescue merger with UBS.

Under the deal, holders of Credit Suisse AT 1 bonds will get nothing, while shareholders who are not typically ranked below bondholders in terms of who gets paid if a bank or company collapses, will get $3.23 billion.

At 1 bonds issued by other European banks fell sharply on Monday as the treatment of Credit Suisse AT 1 bondholders highlighted the risks of investing in this type of debt.

There are some implications of the Credit Suisse AT 1 bond write-down.

AT 1 bonds -- a $275 billion sector, also known as contingent convertibles or CoCo bonds -- act as shock absorbers if a bank's capital levels fall below a certain threshold. They can be written off or converted into equity.

They are part of the capital cushion that banks are required to hold to provide support in times of market turmoil.

They are the riskiest type of bond a bank can issue and carry a higher coupon.

If AT 1 is converted into equity, this helps a bank's balance sheet and helps it stay afloat. They also provide a way for banks to transfer risks to investors and away from taxpayers if they get into trouble.

AT 1 s rank higher than shares in the capital structure of a bank. If a bank gets their money back, bondholders will rank above shareholders in terms of getting their money back.

In Switzerland, the bonds state that the financial watchdog isn't obliged to adhere to the traditional capital structure, which is why bondholders lost out in the Credit Suisse situation.

Credit Suisse AT 1 holders are the only ones not to receive any kind of compensation. Under the rescue deal, they rank lower than shareholders in the bank, who can at least get UBS' takeover price of 0.76 Swiss francs $0.8191 per share.

European regulators said on Monday they would continue to impose losses on shareholders before bondholders - unlike the treatment of bondholders at Credit Suisse.

The Bank of England also said that Britain had a clear statutory order in which shareholders and creditors of failed banks bear losses, with AT 1 instruments ranking ahead of other equity instruments and behind tier two bonds in the hierarchy.

The treatment of AT 1 bonds in a bank overhaul has caused controversy. The Reserve Bank of India initiated a restructuring of the lender in March 2020 and has been subject to court proceedings over the write-off of around $1 billion of AT 1 bonds issued by India's Yes Bank in March 2020.

Fixed income investors were shocked by the Swiss regulator's decision to make Credit Suisse write down its AT 1 debt to zero. They would not have been if they had read the fine print in the bond prospectus.

One bank adviser and a bond investor said the Swiss government's actions were legal since the type of AT 1 bonds issued by Credit Suisse could be subject to a complete write down.

The price of other banks' AT 1 bonds has dropped as investors panicked, fearing their bonds, which were meant to provide more protection than shares, could face the same fate.

The decision to write down Credit Suisse AT 1 bonds to zero is seen as negative for the AT 1 bond market worldwide.

Analysts reckon that investors will be more cautious about buying AT 1 bonds in the future, making it harder for banks to raise money in bond markets to meet regulatory requirements.

The data from Tradeweb shows that bid prices on AT 1 bonds from banks, including Deutsche Bank, HSBC, UBS and BNP Paribas, went up 9 -- 12 points on Monday, sending yields sharply higher.