Why were AT1 bonds of Credit Suisse written off in the UBS takeover bid?
Bonds can be a tricky business, and the risks can be even higher when it comes to AT1 bonds or perpetual bonds.
Indian banks learned this the hard way in 2020 when Yes Bank faced a massive crisis because of these bonds. But it seems history is repeating itself as Credit Suisse Bank is now in hot water, with over $17.3 billion worth of bonds becoming worthless overnight thanks to a takeover bid from rival UBS Group.
UBS stated that it would only go through with the deal if it could write off the bank’s AT1 bonds to zero to increase its core capital.
A few days back, we spoke about the banking crisis surrounding the US, and it was a horrifying time when the stock of Credit Suisse plunged. It gave the American banking crisis a whole new phase. But just in time, the UBS Group came forward to take over Credit Suisse.
Now, the Credit Suisse bank had AT1 bonds of $17 billion which was said to write off to zero as a part of the deal.
But what is AT1 bond in the first place, and why UBS Group wants to write it off?
What is an AT1 Bond?
AT1 bond is a perpetual bond that reputed banking institutions issue. These bonds have no maturity date, which means they will continue to pay interest even when you are old and grey! However, they typically offer an exit option after five years, where investors can choose to redeem or convert their bonds into equity.
But there is a catch. These bonds are classified as Tier-1 capital, the core capital banks hold in their reserves to fund their daily operations. The AT1 bonds can be written off entirely if a bank’s equity is depleted. This means that investors who buy these bonds take on a higher risk level in exchange for the higher interest rate.
Again, what happened that the AT1 bond was written down to zero in the case of Credit Suisse?
The Credit Suisse Issue
Let’s first understand the concept in a simplified way. Suppose a bank has assets of Rs 100, liabilities of Rs 92, and equity of Rs 8. Now, if the asset’s value goes down by 8%, the equity will get wiped off the equation.
This happened with Credit Suisse. It has assets worth ₣531.36 billion, liabilities worth ₣486 billion and ₣45 billion in equity. This data is as of 2022, but a lot has happened since then.
Now, if we look at the reality of Credit Suisse, the company’s share was trading at ₣0.83 on 22nd March 2023, which was ₣7.20 a year back. So, it is clear that the company’s market capitalisation has plummeted significantly (to ₣3.22 billion), and they were drowning in notional losses because of rising interest rates. Reuters report estimates that they had lost a whopping $5.4 billion (that’s ₣4.95 billion), and things were looking grim.
Ultimately, the once-proud Credit Suisse had no choice but to give in to the financial crisis that had engulfed them. Both the companies entered into a stock swap deal as it was a bitter pill to swallow, and the dismissal of the AT1 bonds was a harsh blow to those who had invested their hard-earned money in the bank.
But wait, because there’s a silver lining to this story! Despite the challenges that Credit Suisse faced, the deal with UBS Group has actually turned out to be a fantastic opportunity. That’s because Credit Suisse had some seriously strong shareholders like the Saudi National Bank and the Qatar Investment Authority. And that means that UBS Group has now gained access to a new world of investment potential. So, while it may have been a tough road for Credit Suisse, there’s hope on the horizon for this new partnership with UBS Group.
That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!