The move to write-off $17.5 billion in Additional Tier-1 (AT-1) bonds issued by Swiss based global investment bank and financial services firm , Credit Suisse to a zero-value has caused jitters among market participants globally.
The Swiss government and FINMA, the Swiss Financial Market Supervisory Authority, arranged an all-stock agreement on March 19 that allowed Swiss investment bank UBS Group AG to acquire Credit Suisse for US$3.2 billion.
Following this incident, the government and authorities have begun working to avoid a recurrence, banks are assuring clients of their financial stability, and investors are rushing to find safer investments. Investors are also evaluating whether their AT-1 bonds with other banks might find themselves in the same situation.
What are Additional Tier-1 (AT-1) bonds?
Banks issue AT-1 bonds, a type of unsecured perpetual bond, to increase their core capital base and comply with Basel III norms. These standards, which called for keeping stronger balance sheets, were developed in the wake of a number of banks failing during the global financial crisis of 2008–2009.
Under Basel III norms, banks must keep capital at a minimum ratio of 11.5% of their risk-weighted loans. Tier one capital must make up 9.5% of this. This category of capital includes AT-1 bonds. They give a higher yield as a result of the greater risk involved. These bonds are for long term and does not have any maturity date.
The funds raised via these bonds are also referred to as Contingent Convertible (CoCo) bonds. These bonds are set aside as a shock absorber.
In case of crisis or difficulty, a bank can take the liberty to convert them into equities or write-off like the recent case of Credit Suisse episode and Yes Bank incident from 2020. The Reserve Bank of India (RBI) wrote off the the AT-1 bonds issued by Yes Bank worth ₹8,415 crore to help the struggling private lender.
Bond holders typically come before shareholders in the ranking order when a bank fails. In the Credit Suisse instance, the bondholders won't get any compensation, but the shareholders will.
Panic has spread among bond investors with other institutions due to the hierarchy issue. The fact that Credit Suisse did not file for bankruptcy in the traditional manner is the primary reason why the shareholders will receive compensation while the bondholders won't. It was taken over by other banks without going through the bankruptcy procedure. Therefore, the standard bankruptcy rules did not apply in this case.
The Bank of England and European Union banking regulators reportedly reassured AT-1 investors that they would be given priority over shareholders in the event of a future bank crisis.