The plight of Credit Suisse's AT1 bondholders​

By Jake Rickman
Image credit: rarrarorro / Shutterstock.com​

What do you need to know this week?

Last week we looked at the precipitous sale of Credit Suisse, one of the world’s largest investment banks, to its Swiss rival UBS. The sale was coordinated by the Swiss financial regulators in response to concerns over the bank’s solvency following market volatility in the worldwide banking industry.

As part of our survey of the development, we briefly touched on the fact that Credit Suisse’s so-called AT1 bondholders were wiped out while Credit Suisse shareholders received 1 share in UBS for every 23 shares held in Credit Suisse, valued at $3.2bn in aggregate.

This week, we will drill into the mechanics of the AT1 bonds so you can understand the dynamics at play and why this is a significant development.

Why is this important for your interviews?

The international bond market is a vital source of financing for large businesses around the world. Accordingly, law firms are instrumental in advising borrowers, investors, and underwriters on the various commercial and legal challenges associated with corporate bonds.

Compared to traditional corporate bonds, AT1 bonds are a little different. For starters, they are unique to the banking industry and were created in response to regulatory reforms implemented following the banking sector’s failure in the 2007-08 Global Financial Crisis (GFC). These reforms created two tiers of capital that large banks now had to maintain. The value of the bank’s riskier assets (i.e., riskier loans and bonds it holds) cannot fall below a certain percentage relative to the value of each tier.

email
In effect, the GFC banking reforms allowed banks like Credit Suisse to issue AT1 bonds as a way to boost the capital cushion between Tier 1 and Tier 2. In Credit Suisse’s case, it issued several different AT1 bond programmes with the following general terms:
  • Each investor pays Credit Suisse a portion of the total amount Credit Suisse intends to borrow under each AT1 programme (e.g., 5% of the total offering amount of $2bn);
  • The investors receive from Credit Suisse a portion of notes proportionate to the principal amount the investors advanced Credit Suisse; and
  • The terms of the programme entitles note holders to interest payments paid twice a year, ranging between 3% to 9.75%, depending on the AT1 programme.
Unlike traditional corporate bonds, Credit Suisse’s bonds have no maturity date and are a unique form of so-called “perpetuals [bonds]”. Instead, note holders are entitled to receive indefinite interest payments until they sell their notes to another investor on the secondaries market or Credit Suisse elects to “redeem” the notes (i.e., repay note holders and cancel the notes).

However, to comply with the GFC banking reforms, Credit Suisse’s bonds contained a key provision. In the event of certain “Write-Down Events”, Credit Suisse could cancel the AT1 bonds completely and write their value down to zero, effectively wiping out the AT1 note holders, the effect of which would ideally be to preserve its capital.

These Write-Down Events include if Credit Suisse’s Tier 1 Capital levels fall below 7% relative to its riskier assets, which apparently transpired last week, thereby triggering the write-down of the bonds.

Despite being an express term in the AT1 prospectuses — which are the legal documents setting out the rights and obligations of the AT1 investors and which you can read for yourself (see pages 5-6) — AT1 bondholders believe that the write-down that happened last week was unfair because it violated a fundamental rule of insolvency law. Specifically, that creditors including AT1 bondholders should never be wiped out ahead of shareholders.

Accordingly, they announced their intention to claim against certain Swiss regulators, which facilitated the merger and may have authorised the write-down. Credit Suisse itself may also be in the line of fire. As this is the first time that AT1 bonds have been written down to inadequate capital control, this could have a profound impact on banks’ ability to raise capital in the future.

How is this topic relevant to law firms?

US litigation firm Quinn Emanuel Urquhart & Sullivan, known for its aggressive style of dispute resolution, is representing many of the AT1 bondholders in what will likely be a multi-jurisdictional dispute.