What happened to Credit Suisse's AT1 bonds

What happened to Credit Suisse's AT1 bonds

The Swiss government-brokered takeover of the Bank has kept global markets on their toes. Governments and regulators are making frantic efforts to avoid contagion. They are issuing statements to their customers about their financial health. The investors are rushing to find safer instruments to invest in.

The owners of these have been left out of the game after the UBS deal wiped out $17 billion worth of additional tier one AT 1 of the additional tier one AT 1 of the investors' fears.

The Swiss Financial Market Supervisory Authority said that the government support will cause a complete write-down of all AT 1 shares of Credit Suisse in the amount of around 16 billion Swiss francs.

This has spooked investors as they now assess if this can also happen to their AT 1 holdings in other countries. They are a type of unsecured perpetual bonds that issue to improve their core capital base. The money raised through bonds is kept aside by the bank as a shock absorber. When in trouble, banks can convert to equity or be written down.

The bonds were created in the wake of the 2008 financial crisis to absorb the losses. The chances of a taxpayer payout is reduced by using money raised through these bonds. CoCos or contingent convertible bonds are also called AT 1 bonds.

These bonds are also required under Basel III norms. The banks must maintain capital at a minimum ratio of 11.5 per cent of their risk-weighted loans. Of this, 9.5 per cent need to be in Tier 1 capital. At 1 bonds are not covered by this type of capital.

These bonds are long-term and do not have a maturity date. They offer a higher yield because of a higher risk.

What happened to the AT 1 bonds of Credit Suisse?

When a bank fails, bondholders rank higher in the pecking order than the shareholders. The shareholders will get some compensation while the bondholders won't, in the case of Credit Suisse.

The question of hierarchy has caused panic for bond investors with other banks.

Why do shareholders prefer bondholders over bondholders?

According to a report by CNN, the main reason shareholders will get compensation and bondholders will not is that Credit Suisse did not go through the bankruptcy process and was taken over by other banks. The rules of a typical bankruptcy don't apply here.

The banking regulators in the Bank of England and the European Union reassured AT 1 investors that they would be given priority over shareholders in the event of future bank crises.

Shares of common equity instruments are the first to absorb losses, and only after full use would additional tier one be required to be written down. The approach has been applied consistently in past cases, according to the EU regulators.

Has this happened in any Indian bank?

In 2020, India's private lender wrote off AT 1 bonds worth Rs 8,415 crore as part of its bailout. The Bombay High Court quashed the bank's decision to write off bonds in January of this year, and the investors took the matter to the courts.

There was no disagreement with the hierarchy in that case.

According to CNN, the investors might contest the bank's decision. A litigation firm, Quinn Emanuel Urquhart and Sullivan, has assembled a team of lawyers who were discussing legal options with Credit Suisse's AT 1 bondholders.

In the coming days, investors and fund managers may even move away from investing in AT 1 bonds. According to a report by The Guardian, investors fear that a precedent could be set in this case.

This will increase the cost of AT 1 bonds in the future. The investors would ask for more premiums on these securities.