Why did CS AT1 bondholders suffer the write-down instead of CS shareholders?

I'm surprised that due to the UBS acquisition of CS, CS AT1 bonds were written down instead of shares despite being senior to common equity in the capital structure. I understand that these AT1 bonds were intended to be risky investments that provided liquidity at the bondholders' expense during bank crises, but should the AT1 bondholders still be paid first instead of equity holders?

Comments (18)

Smoke Frog, what's your opinion? Comment below:

I'm going to read up on this topic because your posts sounds interesting, because no way a debt holder would take a large loss before an equity holder. But maybe because this is a forced merger being dictated by the Swiss government they can kind of do whatever they want? Like I read their government basically rewrote laws in a day to skip regular shareholder voting processes.

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Matchstick, what's your opinion? Comment below:

This is what I've gathered so far, someone feel free to correct if I have this wrong:

  1. CS has not declared bankruptcy, so normal repayment waterfall does not apply (i.e. debt getting paid first before equity holders)
  2. The CS AT1s have language that allows the bonds (i) to be converted into equity or (ii) written down when CS's capital buffers are eroded beyond a certain threshold. The second prong is referred to as "bail-in" language, which is what allowed the Swiss regulators to write down the debt to zero.
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SReaper, what's your opinion? Comment below:

Yes, that's pretty much what happened. I know some of the holders of AT1s are very unhappy, questioning the legality of the write-down, so I would assume some litigation will come out of that. Technically only Swiss AT1s allow for this full write-down before equity in specific conditions, such as capital ratios dropping below 7%, or a bailout type event. The UBS merger is less of a merger and more of a bailout, given there is no shareholder vote and massive guarantees from the SNB for UBS.  

sell_side_macro, what's your opinion? Comment below:

The entire point of TLAC debt is to provide a liability that can basically "dissappear" when a bank starts writing off assets. Otherwise how does it help with increasing the loss absorbing capacity of the bank....

slopestyle, what's your opinion? Comment below:

Nail on the head. This was a generally well-understood risk of the AT1/CoCo market post-GFC, for investors bothering to read the docs. What was a well-understood risk in this market (the potential subversion of the capital structure for AT1 holders in stressed scenarios) generally changed in 2016 with the introduction of the BRRD in the EU, which fairly clearly delineated the waterfall by which capital instruments, including bail-in debt, absorb losses, although there is still some ambiguity. Notably, Swiss institutions are not subject to the BRRD.

Key point is that CS' AT1 capital does rank senior to equity capital in the event of resolution/winding-up scenario - this was neither of those. CS' AT1 securities have two write-down triggers: one is based on regulatory capital ratios, the other is at regulatory/supervisory discretion. By prospectus, CS carves out write-down scenarios from the ordinary ranking of the securities in the cap stack. Specifically in this case, FINMA used a PONV (point-of-non-viability) trigger to force the write-down - in CS docs, this is 1.) a regulator (FINMA) has determined that a write-down is necessary because customary measures to improve CS' capital adequacy in order to prevent bankruptcy/insolvency are inadequate or unfeasible, or 2.) customary measures to improve CS' capital adequacy require an irrevocable commitment of extraordinary public sector support in order to prevent bankruptcy/insolvency.  FINMA appears to be hanging its hat on the latter, i.e. without their intervention, CS would be a gone concern (where, in a resolution/liquidation/winding-up scenario, AT1 holders would have preference over common equity holders).

Frankly, prospectus disclosure on this point is fairly straightforward - will be interesting to see if investor lawsuits gain any traction, but feels like their case is weak.

thevillage, what's your opinion? Comment below:

Do you have a better link? Seems this image is pretty compressed.

rickle, what's your opinion? Comment below:

My understanding is that PIMCO was the largest holder of  AT! CS Bonds. Those were wiped out. However, they also held far more regular bonds (10x). Those bonds have actually increased in value as they will become liabilities of UBS. My guess is PIMCO was trying to juice their total return on the whole CS exposure. I think they had 340M of AT1. Win some, lose some. Don't know how long they were getting the extra pop on the AT1. It's all got to be factored in to the overall risk equation.

  • Analyst 1 in PE - Other

I believe PIMCO's still coming out net positive despite the $340M loss. 

WombatsInKombat, what's your opinion? Comment below:

If you have access to the prospectus, there's language in there that basically lets the issuer cram them down to zero almost at will. You'd only feel safe in these securities if you thought the Issue was super healthy or you intended to sell fast. Frankly, I don't see the appeal of holding something like this ever. "Give me a loan with a provision built into it saying that I can just cancel the debt if shit hits the fan" - no thanks

  • Intern in ER

You know, I really hate how the media and the normies twist these matters to make banks and finance people out to be the bad guys. What the normies are thinking is that they are generalizing AT1 to be bondholders in general, and that the banks wiped out the bondholders before stockholders. Typical save the insiders moment! Yay! Wall Street is evil!

What really happened is that these clauses were written into the contract in the 1st place. Basel law was enacted after 2008 to HELP the normies, to prevent using taxpayer money to bail out failing banks. In the case of a bank run, AT1 Cocos auto-convert to equity to buffer the failing bank - that's what justify the 9% yield. These normies and normie investors (the individual Asian investors) lap up the high yield in good times, and when things go south (when that risk embedded in the high yield comes to fruition) they blame the banks for cheating them out. Only AT1 got wiped out, not all bondholders. No one cheated the normies, no one lied to them, no one coerced them into buying AT1. What pisses me more is that my parents also keep harping about how Wall Street cheated normies out again and I can't bring myself to bundle them together with the idiots out there. Come on guys, you all have college degrees, you can't actually be that stupid, can you?

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FlybyWilly, what's your opinion? Comment below:

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