The fret over Credit Suisse AT-1 bond wipeouts prompted the European Banking Authority and the European Central Bank to put out a statement impressing the point that common equity instruments would continue to be the first ones to absorb losses, whereas AT1-s would be written down only afterward. The Bank of England made similar statements.
In Credit Suisse’s case, the investments of AT1 holders have been written off, while common shareholders are set to receive a payout from the deal. According to the established due process, bondholders’ interests must be settled before shareholders’ when a bank fails. But because Credit Suisse’s demise has not followed a traditional bankruptcy procedure, the same rules may not be applicable.
The Credit Suisse AT1 prospectus, seen by CNBC, suggests shareholders may be prioritized over these bondholders — but specifically if the bank fails. But bondholders have questioned whether the bank should be deemed “failing” in the traditional sense — a matter that will likely end up in the courts.
Michael Hewson, the Chief market analyst at CMC Markets, told CNN: “It appears that in this case, because it was not a bankruptcy situation, it was considered that AT1 bondholders and shareholders would both feel the pain.”
AT1 bonds are also known as “contingent convertibles,” or “CoCos”. They were created in the wake of the 2008 financial crisis as a way for failing banks to absorb losses, making a taxpayer-funded bailout less likely. They are a risky bet: AT1s offer a higher yield than senior bonds and most other bonds issued by borrowers with similar credit ratings. if a bond issuer is in trouble and its capital ratio falls below the previously agreed threshold, these types of bonds can be quickly converted into shares, or written down completely. And what this means is that the obligations or liabilities of the bank decline, pushing pressure on the broader banking system.
Credit Suisse's takeover has been the first big test for AT1 bonds.
Analysts predict that the impact will likely spill over into the wider bond market prompting investors to demand higher yields for bonds.
“The real damage is the precedent the write-down may have set”, said Benamou of Axiom Alternative Investments to CNN. “No financial analyst had ever believed that AT1 bonds would be brought to zero… given the level of solvency of Credit Suisse… [and] pretty high level of regulatory capital,” he added.
The cost of insuring against the likelihood of default by European banks rose sharply today, as concern about the outlook for the sector continued to weigh on markets, almost a week on from the collapse of Credit Suisse. Deutsche Bank's five-year credit default swaps jumped 19 basis points (bps) from Thursday's close to 222 bps, according to data from S&P Global Market Intelligence.