No. of Recommendations: 9
UBS agreed to buy Credit Suisse in a historic, government-brokered, all-share deal.
Holders of 'Additional-Tier 1 (AT-1)' bonds have been wiped out. Credit Suisse's roughly 16 billion Swiss francs ($17.3 billion) worth of risky notes are now worthless. The deal will trigger a complete writedown of these bonds to increase the new bank's core capital ' meaning that these creditors have had a worse deal than shareholders, who at least now have some stock in UBS.
'Additional Tier 1' capital was a category introduced under the Basel III banking accords that followed the GFC, with the intention of providing banks with more security. Holders of the bonds were to be behind other creditors in the event of problems. In the first big test of just how far behind they are, we now know that AT1 bondholders come behind even shareholders.
This follows the logic of the post-crisis approach, and it limits moral hazard. The question is whether anyone will want to hold AT1 bonds after this. The market response will be fascinating, and it remains possible that the regulators have avoided repeating one mistake only to make a new one.
https://www.bloomberg.com/opinion/articles/2023-03...
No. of Recommendations: 1
The back and forth between the ECB and SNB on AT1 bonds is pretty interesting.
How do you wipe out Cocos and not wipe out equity?
No. of Recommendations: 9
How do you wipe out Cocos [AT1 bonds] and not wipe out equity?Here's an explanation from the WSJ:
The decision to wipe out Credit Suisse's AT1 bonds has prompted frantic questions among investors. Among them: Why were bondholders wiped out when shareholders weren't?
'What's shocking is that it looks like equity holders will recover better than tier 1 bondholders,' said Justin D'Ercole, co-founder of ISO-MTS Capital Management LP, a fund focused on bank securities. The resulting losses will likely prompt individual and institutional investors to sell similar securities of other European banks, he said.
Traditionally, bondholders rank above equity holders in capital structure. But the Credit Suisse bonds were outliers from other European banks, because they provided for a case where regulators could write them down without wiping out equity holders.
Regulators in the eurozone, which doesn't include Switzerland, clarified that difference with investors Monday.
'Common equity instruments are the first ones to absorb losses, and only after their full use would Additional Tier 1 be required to be written down,' said a statement from the European Central Bank's banking supervision arm, the Single Resolution Board and the European Banking Authority. https://www.wsj.com/articles/credit-suisse-bond-wi...More explanation at WaPo:
They're called contingent convertible bonds, or CoCos ' and are often described as high-yield investments with a hand grenade attached. The takeover of Credit Suisse by UBS Group AG included pulling the pin on $17 billion of CoCos, which are also known as Additional Tier 1 (AT1) bonds.
https://www.washingtonpost.com/business/2023/03/19...So AT1 bondholders are junior to other bondholders, but usually senior to shareholders. But the Credit Suisse AT1 bonds were a little different that way, junior even to sharehoders, but that is not the European norm.
dtb
No. of Recommendations: 2
'How do you wipe out Cocos [AT1 bonds] and not wipe out equity?'
Two words: Saudi Arabia.
No. of Recommendations: 5
More about these AT1's from Matt Levine:
In particular, investors seem to think that AT1s are senior to equity, and that the common stock needs to go to zero before the AT1s suffer any losses. But this is not quite right. You can tell because the whole point of the AT1s is that they go to zero if the common equity tier 1 capital ratio falls below 7%. Like, imagine a bank:
It has $1 billion of assets (also $1 billion of regulatory risk-weighted assets).[6]
It has $100 million of common equity (also $100 million of regulatory common equity tier 1 capital).
It has a 10% CET1 capital ratio.
It also has $50 million of AT1s with a 7% write-down trigger, and $850 million of more senior liabilities.
This bank runs into trouble and the value of its assets falls to $950 million. What happens? Well, under the very straightforward terms of the AT1s ' not some weird fine print in the back of the prospectus, but right in the name '7% CET1 trigger write-down AT1' ' this is what happens:
It has $950 million of assets and $50 million of common equity, for a CET1 ratio of 5.3%.
This is below 7%, so the AT1s are triggered and written down to zero.
Now it has $950 million of assets, $850 million of liabilities, and thus $100 million of shareholders' equity.
Now it has a CET1 ratio of 10.5%: The writedown of the AT1s has restored the bank's equity capital ratios.
This, again, is very explicitly the whole thing that the AT1 is supposed to do, this is its main function, this is the AT1 working exactly as advertised. But notice that in this simple example the bank has $950 million of assets, $850 million of liabilities and $100 million of shareholders' equity. This means that the common stock still has value. The common shareholders still own shares worth $100 million, even as the AT1s are now permanently worth zero.
The AT1s are junior to the common stock. Not all the time, and there are scenarios (instant descent into bankruptcy) where the AT1s get paid ahead of the common. But the most basic function of the AT1 is to go to zero while the bank is a going concern with positive equity value, meaning that its function is to go to zero before the common stock does.
