The treatment of Credit Suisse AT1 bondholders in the rescue by UBS has been controversial and caught the market by surprise.
Additional tier 1 capital securities (or AT1s) are also referred to as conditional convertible securities (or CoCos) and form part of a bank’s regulatory capital. AT1s have a trigger (based on the bank’s common equity tier 1 capital ratio) which, depending on the terms of the AT1, can result in conversion to equity, temporary write-down of the AT1 or, as happened in the case of Credit Suisse, permanent write-down of the AT1 to zero.
The terms of the Credit Suisse rescue package saw holders of approximately US$17bn in AT1s issued by Credit Suisse completely wiped out, while there was some recovery for shareholders. This was seen as a reversal of the usual creditor hierarchy in which equity is the first loss piece in the capital stack and, if there is any recovery for shareholders, a greater recovery for AT1 bondholders would be expected. That being said, the Credit Suisse AT1 documentation provided that FINMA (the Swiss financial regulator) “…may not be required to follow any order of priority, which means, amongst other things, that the notes could be cancelled in whole or in part prior to the cancellation of any or all of [Credit Suisse Group AG’s] equity capital”. The bond documentation also included a “Viability Event” clause (whereby FINMA could notify Credit Suisse of its determination that a write-down was essential to prevent insolvency, bankruptcy, inability to pay a material part of debts, or a cessation of business) which may also have been relied on by FINMA. Nonetheless, FINMA’s approach surprised the market (the Credit Suisse AT1s had been rallying somewhat with the prospect of the UBS rescue). Legal action by some bondholders seems likely.
On Monday 20 March 2023, the European Banking Authority, the Single Resolution Board and ECB Banking Supervision were moved to issue a joint statement confirming that, in the case of a troubled Eurozone bank, the assumed creditor hierarchy in which shareholders bear first loss would apply:
“In particular, 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. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.”
In a similar announcement, the Bank of England stated “AT1 instruments rank ahead of CET1 and behind T2 in the hierarchy [in which shareholders and creditors would bear losses in a resolution or insolvency scenario]. Holders of such instruments should expect to be exposed to losses in resolution or insolvency in the order of their positions in this hierarchy.”