Write-Down of Credit Suisse’s AT1 Instruments

What is the purpose of AT1 securities? 

AT1 capital securities have a "going concern principal loss absorption" feature that allows them to absorb losses and behave more like equity in times of distress, with certain write-down features triggered by specific events. These securities have a "living" function and their operation changes depending on the health of the bank and the regulator's stance in times of distress. Liquidation preference ahead of ordinary shareholders is somewhat of a mirage as these securities will have been triggered well before liquidation ever kicks in.

How does the loss absorption function work in AT1 securities?

To understand loss absorption for AT1 securities, investors should focus on what happens to the principal value of the security and what qualifies as distress. 

In the case of Credit Suisse's (CSG) AT1 securities, a write-down event would result in the full principal amount being written down to zero, with no commitment to preserve the creditor hierarchy. 

Distress can be triggered by breaching the CET ratio or by a Viability Event outlined in the prospectus. 

The Swiss authorities provided extraordinary support to CSG, resulting in a write-down of AT1 securities, but this does not deny the operation of the published terms of the securities. The emergency law should be viewed in the context of the AT1 securities and not as an acknowledgement of their ineffectiveness to result in a write-down.

What is the difference between non-viability, insolvency and solvency? 

Viability and solvency are two separate concepts in the context of bank rescues. Viability refers to a bank's ability to operate independently without any form of extraordinary state support, while solvency pertains to its ability to pay debts as they fall due. 

Credit Suisse took extraordinary liquidity support from FINMA prior to the write-down of its AT1 securities, indicating that it met the definition of non-viability. 

However, solvency and viability are not the same, and a bank can be solvent but non-viable. In bank rescues, restoring both liquidity and capital is crucial to restore market stability and satisfy stakeholders' demands.

Were the risk factors in the CSG AT1 prospectus clear?

The prospectus for Credit Suisse's AT1 securities makes it clear that a write-down is a material risk, and holders may lose their entire investment, even if existing preference shares, participation certificates, or ordinary shares remain outstanding. 

The trigger for a write-down is unpredictable and outside CSG's control, and holders have no right under Swiss law to challenge any protective measures imposed by FINMA. The regulator accepted that write-down instruments could be beneficial to shareholders in certain circumstances, making them acceptable for regulators.

What are the key learnings from the CSG AT1 fiasco?

Key learnings for investors:

• Read and understand the prospectus, including risk factors
• Understand the Basel III framework and risks for capital securities
• Don't assume traditional creditor hierarchy will be respected
• Banking regulator has power to restore market confidence in crisis
• Know relevant resolution legislation of issuer's jurisdiction
• Don't assume different instruments have the same risk profile