Reflections on Credit Suisse AT1 Bonds Write-Down Event
In order to prevent the spread of a banking crisis and alleviate financial disruptions to restore market confidence，UBS reached an agreement to acquire Credit Suisse AG for 3 billion Swiss francs on March 19 with the assistance of the Swiss government. To facilitate UBS's acquisition of Credit Suisse，the Swiss National Bank provided liquidity support of 100 billion Swiss francs along with a loss guarantee capped at 9 billion Swiss francs. Meanwhile，Swiss financial markets regulator FINMA stated that other Additional Tier 1 (AT1)bonds with a nominal value of approximately 16 billion Swiss francs would be written down completely. This move sparked a lot of discussion in the market. On March 23，in a statement，FINMA explained the rationale behind the full write-down of Credit Suisse’s AT1 bonds and the regulatory requirements for AT1 bonds under Swiss law. However，it still triggered a heated debate on whether it is reasonable for AT1 bonds to be written down before equity.
Introduction to AT1 Bonds
Basic Concept of AT1 Bonds
AT1 bonds belong to a category of assets known as contingent convertible bonds，or CoCos. They are convertible bonds designed as capital instruments under the European regulatory framework after the 2008 global financial crisis. The purpose of AT1 bonds is to help banks absorb losses in the event of a bankruptcy crisis，thereby reducing the financial burden on taxpayers and governments.
A bank’s Tier 1 capital includes Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1). Generally， AT1 capital instruments are paid after deposits，general creditors，and subordinated debt，but before common stock，in the event of a bank’s insolvency or liquidation，for instance. In other words，bondholders will receive greater financial returns than stockholders.
Main Features of AT1 Bonds
According to Bloomberg，the global AT1 bond market is worth about USD 1 trillion，involving about 1,400 bonds. The main features of AT1 bonds are as follows:
First，AT1 bonds have been given a loss absorption mechanism，which is the most prominent feature. In general，AT1 bonds will set loss absorption trigger events，which happen when the issuer’s CET1 capital falls below a pre-determined threshold，the specific level of which is determined by each country’s regulatory agency，or when it reaches the Point of Non-Viability (PONV). The AT1 bonds will be converted into equity or written down in accordance with the bond terms once the loss absorption mechanism has been activated.
Second，AT1 bonds have no fixed term，but the issuer may redeem it under certain conditions. The reason why AT1 bonds have no maturity date is because the bank capital is permanent，but the issuer may redeem it under certain conditions. Despite this feature，after the call protection period (generally 5 or 10 years)，the market usually expects the issuer to redeem the AT1 bonds and replace them with new ones.
Thirdly，interest onAT1 bonds is non-cumulative and may be partially or fully eliminated without triggering a default. The issuer can cancel interest payments partially or entirely，and unpaid interest will not accumulate to the next interest period.
Analyzing the Rationale for the Full Write-Down of Credit Suisse’s AT1 Bonds
According to the design principles of AT1 bonds，it is reasonable for the Swiss government to require the full write-down of Credit Suisse’s AT1 bonds. However，UBS’s takeover of Credit Suisse resulted in the partial preservation of shareholder equity，while the rights of AT1 bonds investors were completely wiped out. This means that shareholders rank higher in the repayment than those investors，contrary to the common practice mentioned above，thus provoking market discussions.
Explanation From the Swiss Regulatory Authorities
On March 23，FINMA explained in a statement that the write-down of Credit Suisse’s AT1 bonds was under the prospectus of Credit Suisse AT1 bonds and the Swiss Federal Council’s Emergency Ordinance on Additional Liquidity Assistance Loans and the Granting of Federal Default Guarantees for Liquidity Assistance Loans from the Swiss National Bank to Systemically Important Banks (hereafter referred to as the “Emergency Ordinance”).
In its statement，FINMA further declared that the AT1 instruments in Switzerland are designed in such a way that they would be written down or converted into common equity Tier 1 capital before the relevant bank’s equity is fully used up or written down. In other words，under Swiss law，AT1 is written down prior to equity as long as the bank continues operating.
Provisions of Issuance of Credit Suisse AT1 Bonds
According to the prospectus for Credit Suisse AT1 bonds，two cases will eventually trigger the write-down clauses. When either occurs，AT1 bonds will be automatically and permanently written to zero. Take AT1 bonds issued in 2022 with a face value of USD 1.65 billion and a coupon rate of 9.75%，for example.
One case is the contingency event，referring to a sudden event that Credit Suisse’s CET1 capital ratio falls below the specified threshold. The other event concerns viability. Firstly，when the regulatory agency determines that Credit Suisse's regular measures to increase its capital adequacy ratio are inadequate or unworkable，the bond write-down will prevent the bank from defaulting on its debts，declaring bankruptcy，failing to pay most of its debts，or ceasing operations. Secondly，if Credit Suisse cannot enhance its capital adequacy via conventional means，and the bank secures an irrevocable commitment of exceptional support from the public sector (beyond routine transactions and arrangements) to boost its capital adequacy ratio，the regulatory agency will consider the bank insolvent，bankrupt，unable to pay most of its debts，or unable to continue its business if such support is not available.
The Swiss financial regulatory authority，FINMA，has confirmed that UBS was able to acquire Credit Suisse with the support of the Swiss National Bank，which provided a liquidity injection of 100 billion Swiss francs and a maximum loss guarantee of 9 billion Swiss francs. This was exactly the “extraordinary support” that triggered the write-down clause of Credit Suisse’s AT1 bonds.
Impact of Credit Suisse AT1 Bonds Write-Down Event
In the Short Term，the Global AT1 Bond Market Faces Pressure
Firstly，in order to reduce risk exposure to the banking industry and investment losses，investors may sell AT1 bank bonds with poor asset quality and credit ratings，resulting in lower AT1 bond prices. As the Credi