Joined: Thu Sep 30, 2010 3:40 pm
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denisdman wrote: Jaw Breaker wrote: How the hell did Credit Suisse’s AT1 bondholders get zeroed out completely while shareholders did not and will get about a 40% recovery? Only thing I can think of is that the Swiss gov believes there are more voters who own shares than bonds. Reminiscent of the bullshit that occurred in 2008 with GM. It does not make sense. I assume the thinking is they need shareholders to approve the sale, so they had to give them something. Yeah, I think you’re right. As my guy Matt Levine (Bloomberg) said today, “it is hard for the board of directors of the selling company to say to their shareholders ‘hey we negotiated the best possible price for you, which is zero.’ ” But more importantly: After the 2008 financial crisis, European banks issued a lot of what are called “additional tier 1 capital securities,” or “contingent convertibles,” or AT1s or CoCos. The way an AT1 works is like this:
It is a bond, has a fixed face amount, and pays regular interest.
It is perpetual — the bank never has to pay it back — but the bank can pay it back after five years, and generally does.
If the bank’s common equity tier 1 capital ratio — a measure of its regulatory capital — falls below 7%, then the AT1 is written down to zero: It never needs to be paid back; it just goes away completely.
This — a “7% trigger permanent write-down AT1” — is not the only way for an AT1 to work, though it is the way that Credit Suisse’s AT1s worked. Some AT1s have different triggers. Some AT1s convert into common stock when the trigger is hit, instead of being written down to zero; others are temporarily written down (they stop paying interest) when the trigger is hit, but can bounce back if the equity recovers.
These securities are, basically, a trick. To investors, they seem like bonds: They pay interest, get paid back in five years, feel pretty safe. To regulators, they seem like equity: If the bank runs into trouble, it can raise capital by zeroing the AT1s. If investors think they are bonds and regulators think they are equity, somebody is wrong. The investors are wrong.
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).
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.
Credit Suisse has issued a bunch of AT1s over the years; as of last week it had about CHF 16 billion outstanding. Here is a prospectus for one of them, a $2 billion US dollar 7.5% AT1 issued in 2018. “7.500 per cent. Perpetual Tier 1 Contingent Write-down Capital Notes,” they are called.
In UBS’s deal to buy Credit Suisse, shareholders are getting something (about CHF 3 billion worth of Credit Suisse shares) and Credit Suisse’s AT1 holders are getting nothing: The Credit Suisse AT1 securities are getting zeroed. This is not, to be clear, exactly because Credit Suisse’s CET1 capital fell below 7%; instead, there is a separate clause of the AT1s allowing them to be zeroed if the bank’s regulator decides that zeroing them is “an essential requirement to prevent CSG from becoming insolvent, bankrupt or unable to pay a material part of its debts as they fall due.” Plus, in a situation like this, the banking regulators get to do a certain amount of ad hoc stuff, and they do. (They got rid of the shareholder vote on the deal!) Zeroing the AT1s while preserving a little value for the common does seem to have been done in an ad hoc way; my point is just that it follows very logically from the terms and function of the AT1s. _________________ To IkeSouth, bigfan wrote: Are you stoned or pissed off, or both, when you create these postings?
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