Tier 1 capital
Of a regulated financial institution, the capital level below everything else than gives comfort to the creditors — in particular, its depositors — that those debts will be met. The most obvious type of tier one capital is the institution’s share capital — “tier 1 common equity”. But also is alternative tier 1 capital, also known as AT1, eighty-one, which takes the form of contingent convertible securities (“co-cos”). It became clear in March 2023 when Credit Suisse finally gave up the ghost, that many in the market, including its AT1 investors, didn’t fabulously understand how it worked. (In fairness to them, it wasn’t obvious, even though it was written into the terms and even the title of the AT1 Notes).
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Regulatory Capital Anatomy™
The JC’s untutored thoughts on how bank capital works. From our machine overlords Here is what, NiGEL, our cheeky little GPT3 chatbot had to say when asked to explain:
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Debit Suisse and the irate bondholders
Famously, in that panicked Spring weekend in 2023 when it slipped into history[1] the “trinity” of Swiss regulators put a gun to UBS’s head, forced it to make an honest bank of Credit Suisse in a process in which it absorbed Lucky’s equity, and the jewels and hellish instruments of madness and torture secreted around its balance sheet — other than its AT1s. The regulators instead, by ordinance, directed Lucky to write down its Perpetual Tier 1 Contingent Write-Down Capital Notes to zero.
This — and there isn’t really a delicate way to put this, readers so let’s just come out with it — pissed the AT1 bondholders the hell off.
Their indignance was largely driven by foundational conceptions of what subordinated debt securities are meant to be — that is, senior to equity holders — rather than even a cursory glance at the terms or, goddammit, even the title of their Notes.
They were fortified in their dudgeon by other central bankers (BOE, ECB, the Fed) unhelpfully announcing, for the record, that that is not how they would expect to treat AT1s (you can just imagine FINMA honchos going “yeah, thanks Pal,” when a central banker from Greece — yes, yes, that Greece — went on record as saying “well needless to say we’d never do anything like that. We Greeks are civilised, not like the Swiss!”[2]
Now ambulance chasing litigators are whipping up even more foment, indelicately trawling LinkedIn to raise a pitchfork mob of aggrieved investors to go and sue — well, it isn’t clear who they would sue, or for what, since this was done by legislation — and the normally mild-mannered community of financial analyst commentariat has been periodically erupting into virtual fist-fights about what the Notes do or do not say. Lots of jilted lover energy: “How could I ever trust a central banker again?” sort of thing, and lots of “who knew Switzerland was a banana republic?” vibes, too.
The JC likes Switzerland, so he is staying out of that debate. In any case there are plenty of thought pieces from those more learned and temperate than the JC about that.
But still
But the conceptual question this all throws up, in the abstract, is an interesting one: everyone understands AT1s could get converted into equity, at which point they rank equally with shareholders, and even written off. But there seems to be an expectation that should only happen if common shareholders are getting written off too.
But should subordinated creditors holders ever rank behind common equityholders? Surely not?
And, a little spoiler: effectively ranking behind shareholders and actually ranking behind shareholders feel similar — especially if you have just been written down to zero while the shareholders live to see another day — but they are quite different things.
A corporation’s equity holders take all the profit and all the losses of the undertaking. You can only work out what those profit and losses are once every other claim on the enterprise has been settled. Those other claims have the feature of being debtor claims. Debtor claims all have defined payoffs; equity claims are, “whatever’s left”.
So, when resolving a company that has gone bust you must deal with AT1 creditors before you finally settle up with shareholders. You can do this two ways: you can convert the AT1s into shares or, if its terms permit, you can just write it off altogether. Either way, no AT1s are left. You have only shareholders now.
The AT1 investors do not, therefore, actually rank behind equity holders. They cannot. They either are equity holders, or they are goneski.
If they AT1 holders get converted into equity they may get some recovery, but only once all the company’s other creditors have been repaid in full: that is the lot of the equity investor. Note that those “other creditors” will not include any AT1 investors: the AT1s will either have been converted to equity, or written off, but they won’t — can’t — still be there. The AT1s do not actually rank behind common equity.
Nonetheless, those AT1 investors whose Notes are written off are goneski — who are written off altogether
See also
References
- ↑ We have a sense Credit Suisse’s history is not done just yet but that, like Disaster Area frontman Hotblack Desiato, it is merely spending a year dead for tax (and, er regulatory capital) purposes. It may well be back, at least as a high-street banking brand in Switzerland.
- ↑ This is a paraphrase, and an exaggeration for effect, I freely admit.