A Rs 142,496-crore jolt for Credit Suisse's AT1 bondholders. Read what happened

Logos of Swiss banks UBS and Credit Suisse seen on an office building in Zurich, Switzerland March 19, 2023. (Image Source: REUTERS/Denis Balibouse)

In an ‘all-Swiss’ deal, Switzerland's largest lender UBS Group on March 19 agreed to buy its struggling rival Credit Suisse for almost $3.25 billion in an effort to prevent further disruption to the global banking system.

The acquisition, brokered by the Swiss authorities, was proposed after a failed attempt by Credit Suisse to borrow up to $54 billion, which failed to instill confidence in investors and customers.

As part of the deal, Swiss financial regulator Finma ordered that $17.3 billion (approximately Rs 142,496 crore) worth of additional tier one (AT1) bonds will be written down to zero.

“The extraordinary government support will trigger a complete write-down of the nominal value of all AT1 shares of Credit Suisse in the amount of around CHF 16 billion, and thus an increase in core capital,” it said.

Let's try and understand AT1 bonds, risks and other important features.

What are AT1 bonds

AT1 bonds are a type of bond issued by banks to raise money from investors. The Additional Tier 1 (AT1) bond is a regulatory classification of these bonds as a form of capital that can absorb losses in times of financial stress.

The Basel accord introduced these bonds as a measure to safeguard depositors in the aftermath of the 2007–08 financial crisis.

Why AT1 bonds are risky investments

As per experts, the AT1 bonds are perceived as riskier because they have no maturity date and their interest payments are not guaranteed. Additionally, their value can vary greatly depending on the financial health of the issuing bank.

In AT1 bonds, investors are exposed to higher risks of default or loss, compared to traditional bonds and in times of financial stain, the AT1 bonds can be written off entirely, as it has happened in the case of Credit Suisse, which means loss of investment for bondholders.

AT1 bonds are subordinate to all other debt and only senior to common equity. The order of repayment during the restructuring or liquidation of a bank is: First, to fixed deposit holders, then to secured debt holders, followed by unsecured or subordinate debt holders, and finally to perpetual debt holders, including AT1 bondholders.

The AT1 bonds typically offer higher yields to investors owing to the uncertainty embedded in these instruments.

At1 Bonds versus Equity at Credit Suisse

UBS will acquire Credit Suisse for around $3.25 billion in an all-share deal, a big discount to Credit Suisse’s market capitalisation at Friday’s close of $8 billion and an ever-bigger discount to its end-2022 shareholders’ equity of $48.7 billion.

In short, shareholders have been offered one UBS share for 22.48 CS shares, valuing the CS shares at CHF 0.76 (and the group at CHF 3 billion) – well below the latest market value, but well above zero. In other words, AT1s are being written off while shares retain some value.

"It is not entirely clear yet on what basis the AT1s are being written down… However, to do this while not wiping out equity looks very short-sighted to us, as it highlights the power of regulators to behave unpredictably vis-à-vis AT1 bondholders, who have less of a voice than shareholders," CreditSights said in a note released today morning.

AT1 bonds India

In March 2020, Yes Bank's reconstruction scheme led to the write-off of Additional Tier-1 bonds worth Rs 8,415 crore. However, in January, the Bombay High Court overturned this decision. The Supreme Court later issued a stay on the Bombay High Court's order.

The petitioners claimed that Yes Bank executives misrepresented the risks associated with the bonds, promoting them as 'Super FDs' to fixed-deposit holders by assuring them of higher returns and safety.