Additional Tier 1 bonds were introduced in Europe after the global financial crisis in 2008 to serve as shock absorbers when banks start to fail. AT1s are a deeply subordinated debt eligible for regulatory capital requirements/purposes under Basel 3. The instruments are designed to absorb losses in two ways: the first is via partial or complete suspension of coupon payment at the discretion of the issuer and the second is via either a (full or partial/temporary or permanent) principal write down or a (full or partial) conversion of the nominal amount into equity. The latter is triggered by a so-called quantitative capital trigger event with a predetermined regulatory capital ratio (5.125% or 7%). This bond segment has been sharply growing over the last decade to reach a size of about $250bn.

The only time AT1 bonds were written down was in the case of Banco Popular Español. In 2017, the Single Resolution Board (SRB) triggered the resolution of Banco Popular Español. This decision was based on the ECB's conclusion that the bank was imminently non-viable, given the rapid deterioration in liquidity and the failure of the sale process. To ensure continuity of operations and preserve financial stability, the SRB decided to transfer Banco Popular Español to Banco Santander. To fill in the capital shortfall, all shares and AT1 instruments were written down and Tier2-Securities (T2s) converted into shares transferred to Santander for the price of 1 euro. 

The Credit Suisse case is different, as liquidity and capital ratios were above minimum requirements. But market and investor sentiment toward the bank was so negative that it could not be restored, according to the Swiss authorities. Even after a statement from the Swiss authorities that the bank was solvent.  At this point, a merger with UBS was the most viable and fastest solution. Credit Suisse shareholders will receive 3 billion dollars in UBS shares, Credit Suisse AT1 bondholders will be reduced to zero, and UBS will receive a $200 billion liquidity line and other guarantees from the Swiss government. To complete the deal, Swiss authorities excluded shareholders from the approval process in a law passed Sunday night and wiped out all AT1 bondholders. The consequences for Credit Suisse AT1 bonds were swift: all AT1 bonds plunged to (almost) 0 on Monday.

Credit Suisse Additional Tier 1 bond – Price evolution 

Source: Bloomberg

The regrettable and peculiar treatment of CS bondholders in Switzerland should not cause a credit crunch and recession in the Eurozone.  AT1 is a liquid asset class, majorly held by institutional investors and any consternation caused by Swiss regulators not respecting the creditor hierarchy at Credit Suisse should been seen as an idiosyncratic event. 

European banks are in a much stronger capital and liquidity position than in 2008 or 2012. 

European bank’s capital levels are at multi decade highs

Source: ECB

The Eurozone and UK authorities have already provided welcome reassurance to credit investors via their press release. The Covid crisis is a good example of their policy towards credit investors, when in 2020 they temporarily decided the ban of dividends but maintained the payment of AT1 coupons. 

In Europe, it would not be possible to write down Credit Suisse AT1 to zero whilst equity recovered value thanks to the Directive Resolution (BRRD). Eurozone authorities also stated in their statement "additional Tier 1 will remain an important component of the capital structure of European banks." This last point is very important for bank’s future required capital levels. The AT1 market is therefore here to stay. Since their creation, AT1s have been issued by banks to optimize their capital structure, mainly by Global Systemically Important Financial Institutions (G-SIFI) and national champions, which have an ample market access. 

In other words, this event is specific to Switzerland and not applicable to other regions as demonstrated by European regulators and the Bank of England speaking almost in unison to distinguish their approach from the one taken by FINMA. Swiss banks' AT1 will now require structurally higher risk premium than EU and UK. And they will also need to be clear about the way they treat investors and probably show more investor friendliness.