View| Credit Suisse fiasco shows the ugly side of AT1 bonds

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

The real casualty of the UBS-Credit Suisse deal is the Additional tier 1 bonds (AT1) bond holders. AT1 bond refers to a type of perpetual bond instrument that came into prominence post the 2008 global financial crisis, as a way for banks to boost their core equity. These bonds offer higher interest rates, compared with the traditional bonds and carry no maturity date. These papers are also known as contingent convertible bonds or CoCo bonds.

The problem in such securities is that when the storm hits, there will be no place to hide. In the event of a bank failure like in the case of Credit Suisse, AT1 bond holders will get zilch on their investments. All depends on what are the deal terms. Strictly going by the book, shareholders should first take the hit before AT1 holders. But that’s not what happened in the case of the government-brokered UBS-CS marriage.

In the case of CS, about $17 billion worth of bonds issued by CS were written down. Among the investors who lost money is bond giant US-based Pacific Investment Management Co (PIMCO), which lost about $340 million. And the AT1 bond disaster of Credit Suisse won’t end here, the damage will be widespread. According to a Reuters report, prices on similar bonds from European banks fell sharply on Monday after Credit Suisse's wipe-out of such debt raised concerns about the broader sector.

But, why do people invest in AT1 bonds despite the high-risk nature? One reason is that the returns offered by these bonds are typically higher compared with other bonds. The other is ignorance. Retail investors typically take the word ‘bond’ for safety and assume that they get the money back on maturity. But that’s not the case with AT1 bonds. These bonds have no maturity date, but only a call option, which banks can exercise to buy these bonds back from investors.

In hindsight, the AT1 bond holders of Credit Suisse could have averted the tragedy had they paid attention to a similar episode in 2020 in Mumbai-based YES Bank. YES Bank, which collapsed under fraud and the burden on risky assets, had written off a massive Rs 8,414 crore (around $1.03 billion then). Besides the institutional investors such as 63 Moons Technologies and Indiabulls Housing Finance, there were several retail investors who had invested their hard-earned money in AT1 bonds.

These investors have been fighting a long battle since then. Early this year, these investors got some relief when Bombay High Court quashed YES Bank’s decision to write down these bonds. But, the Supreme Court put this order on hold on March 3. According to a Reuters report, AT1 bond holders of Credit Suisse too, may evaluate moving the courts, challenging the AT1 bond write-down. However, their chances of succeeding are slim. Once the crisis hits these bonds, investors typically don’t have a happy ending in the story.