In Spotlight: What Are Additional Tier 1 (AT1) Bonds and How Do They Function?

On Sunday, 19 March 2023, the Swiss government, the Swiss National Bank (SNB), the Swiss Financial Market Supervisory Authority (FINMA) together with UBS and Credit Suisse (CS) announced that UBS and CS will enter into an emergency merger; UBS shall absorb CS by paying CHF 3 billion in UBS’ own shares. Among other emergency measures, FINMA ordered the complete write off of CS’s Additional Tier 1 (AT1) bonds in the total amount of CHF 16 billion.

In the following, we provide a short overview about the different types of additional capital in banks as well as how and when they may or must be triggered.

1. Types of Additional Capital

Swiss banking regulations basically offer the following three forms of additional capital for banks and the ultimate parent companies of financial groups and bank-dominated financial conglomerates:

1. Reserve capital: The articles of incorporation may authorize the Board of Directors to increase the share or participation capital.
2. Contingent convertible capital (CoCo Bonds): The articles of incorporation may provide for an increase in share or participation capital to be effected by the conversion of mandatory convertible bonds upon the occurrence of a specified event.
3. Bonds with waiver of claims (Write-Off Bonds): The terms and conditions of issue of bonds may provide that creditors waive claims upon the occurrence of a specified event.

The mechanics of such Additional Capital instruments look as follows on the balance sheet of a bank when triggered:

2. Point of Non-Viability (PONV)

The terms and conditions of issue of CoCo Bonds or Write-Off Bonds or the articles of association of the bank must make provision for AT1 capital to contribute to the bank’s restructuring by means of a complete write-off or conversion at the point of non-viability (PONV). In this case, creditors’ claims must be written off in full. Based on that, writing off only a part of such Write-Off Bonds is not allowed.

The conversion to CET1 capital or the write-down must take place at the latest:

1. before recourse to public sector assistance; or
2. when FINMA orders this to avoid insolvency.

3. Credit Suisse’s AT1 Bonds

E.g. on 23 June 2022, Credit Suisse Group AG (CSG) issued the Perpetual Tier 1 Contingent Write-down Capital Notes in the total amount of USD 1,650,000,000 for an initial interest rate of 9.750% per annum.

As required by law and described above, the terms and conditions of issue explicitly state that “Following the occurrence of a Write-down Event, a Write-down will occur and the full principal amount of the Notes will automatically and permanently be written-down to zero on the Write-down Date.”

A Write-down Event means either a:

1. a Contingency Event: CSG is required to issue a contingency event notice if the CET1 ratio is below 7.00%; or
2. a Viability Event:

1. the Regulator has notified CSG that it has determined that a write-down of the notes is essential to prevent CSG from becoming insolvent, bankrupt or unable to pay a material part of its debts as they fall due, or from ceasing to carry on its business; or
2. CSG has received an irrevocable commitment of extraordinary support from the Public Sector that has the effect of improving CSG’s capital adequacy and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business.

4. Conclusion

The outstanding AT1 Bonds of CSG seemed to be Write-Off Bonds and not CoCo-Bonds. Whereas CoCo-Bonds are converted into shares (i.e. equity), Write-Off Bonds are written off completely without any consideration (part-write-off is not allowed). The Swiss banking regulations provide explicitly for these instruments and at least CSG’s terms and conditions of issue of 23 June 2022 seem to comply with the legal requirements. This has the interesting effect that shareholders are better off than holders of Write-Off Bonds in case of a Write-down Event. However, this is exactly the intended purpose of the legislator for this type of financial instrument. Therefore, interest rates for such AT1 Bonds are typically significantly higher than for ordinary bonds.

Based on FINMA’s press release of 23 March 2023, FINMA ordered CSG to write off the AT1 Bonds because of a Viability Event based on the terms and conditions of issue as well as the emergency ordinance enacted by the Federal Council on 19 March 2023 regarding additional liquidity assistance loans and the granting of Federal default guarantees for liquidity assistance loans by the SNB. It will likely be subject to court decisions whether the requirements for such a Write-down Event have actually been fulfilled on 19 March 2023.