I’m always interested to learn about investment vehicles that are new to me.
AT1 bonds are popular among European banks as a way to build up safety buffers. Following the 2008 financial crisis, many countries in Europe signed on to a regulatory framework called Basel III, under which they passed laws requiring large banks to maintain a financial cushion for protection during a downturn.
This capital buffer is grouped into two “tiers” and must meet minimum levels in proportion to banks’ assets when adjusted for risk. Tier 1 capital is made up mainly of equity, while Tier 2 capital can be made up of other securities. AT1 bonds are considered in a distinct category of Tier 1 instruments and can make up a portion of banks’ core regulatory capital requirements.
While AT1s pay high interest to bondholders, their mechanics can make them a risky investment. AT1s have triggers that allow the issuing bank to convert, reduce or completely erase the bond’s principal value in order to preserve its Tier 1 capital.One risk associated with AT1s is that regulators have the authority to convert the bonds to equity or reduce the value of the bonds. … [end quote]
This is a completely different kind of risk than risk of default by corporate bonds that is rated by the bond-rating firms (S&P, Moody’s, Fisk). The familiar bond ratings express how likely a company is to default on its interest payments during adverse economic situations, such as a recession.
AT1 bonds are different. They are part of a bank’s equity. If the bank fails the AT1 bonds can be wiped out. This is different from a bank failure where a larger bank absorbs the assets and liabilities of a smaller failed bank and could pay off the bond holders of the failed bank.
By Anna Cooban, CNN, Mon March 20, 2023
It is not the write-down of Credit Suisse’s AT1 bonds that has rocked investors, but the fact that the bank’s shareholders will receive some compensation when bondholders will not.
Ordinarily, bondholders are higher up the pecking order than shareholders when a banks fails. But because Credit Suisse’s demise has not followed a traditional bankruptcy, analysts told CNN, the same rules don’t apply… [end quote]
European banks are the largest issuers of AT1 bonds. The largest issuers are Credit Suisse Group, Societe Generale, Barclays, Deutsche Bank and HSBC.