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Matt Levine [1]: > This — a “7% trigger permanent write-down AT1” — is not the only way for an AT1 to work, though it is the way that Credit Suisse’s AT1s work

Matt Levine [1]: > This — a “7% trigger permanent write-down AT1” — is not the only way for an AT1 to work, though it is the way that Credit Suisse’s AT1s worked. Some AT1s have different triggers. Some AT1s convert into common stock when the trigger is hit, instead of being written down to zero; others are temporarily written down (they stop paying interest) when the trigger is hit, but can bounce back if the equity recovers. (Here is a 2013 primer on CoCos from the Bank for International Settlements.) > These securities are, basically, a trick. To investors, they seem like bonds: They pay interest, get paid back in five years, feel pretty safe. To regulators, they seem like equity: If the bank runs into trouble, it can raise capital by zeroing the AT1s. If investors think they are bonds and regulators think they are equity, somebody is wrong. The investors are wrong. > In particular, investors seem to think that AT1s are senior to equity, and that the common stock needs to go to zero before the AT1s suffer any losses. But this is not quite right. You can tell because the whole point of the AT1s is that they go to zero if the common equity tier 1 capital ratio falls below 7%. > ... > That's the trick! The trick of the AT1s — the reason that banks and regulators like them — is that they are equity, and they say they are equity, and they are totally clear and transparent about how they work, but investors assume that they are bonds. You go to investors and say “would you like to buy a bond that goes to zero before the common stock does” and the investors say “sure I’d love to buy a bond, that could never go to zero before the common stock does,” and the bank benefits from the misunderstanding. [1] https://www.bloomberg.com/opinion/articles/2023-03-20/ubs-got-credit-suisse-for-almost-nothing https://www.bloomberg.com/opinion/articles/2023-03-20/ubs-go...

dang 4y ago
Related: UBS got Credit Suisse for almost nothing - https://news.ycombinator.com/item?id=35236043 https://news.ycombinator.com/item?id=35236043 - March 2023 (117 comments)
JumpCrisscross 4y ago
TL; DR Swiss AT1 securities are unlike others. If the SNB said the right magic words first (CET1 < 7%), this is proper form.
- NoboruWataya 4y ago
  Not according to Levine, who points out that this write down is not a result of CET falling below 7%, but a separate clause in the bonds that kicks in where a regulator decides it needs to zero the bonds to prevent CS's insolvency. Other AT1s apparently do not have such clause, but that doesn't mean investors in those bonds are entirely safe from this ever happening to them. In the EU there is BRRD, which gives regulators extensive powers to resolve failing banks pretty much however they see fit. However, EU regulators have apparently put out a statement saying (basically) that they wouldn't do it this way and would let shareholders take the hit first. It's a little surprising to me that they would tie their hands like this, but I guess a lot of EU banks are heavily reliant on AT1 funding so they felt they had to do something to restore confidence.
  - JumpCrisscross 4y ago
    > this write down is not a result of CET falling below 7%, but a separate clause in the bonds that kicks in where a regulator decides it needs to zero the bonds to prevent CS's insolvency That write-down to zero (versus automatic conversion) was front and centre makes the Swiss precedent limited, in my opinion. Nobody who ever trades AT1s will have public opinions about it. But from what I can tell, the rules were followed.
    - cjbgkagh 4y ago
      It’s only limited if everyone was informed before, and informed now. Given the market moves neither appear to be the case. The mere impression of the open ended risk is sufficient to cause contagion. People will be looking closer at the regulatory discretion clauses in bail in legislation and probably not liking what they see.
      - JumpCrisscross 4y ago
        > the market moves neither appear to be the case A significant amount of that movement is being driven by Asian retail. How they were sold these is another question. AT1s without write-down may be a smart buy at the moment.
nytesky 4y ago
Reminds me of auction rate securities and exchange traded notes. Seeming to have less risk, but with limited upside, and whoops worse downside.
ethbr0 4y ago
If counterparties bought Credit Suisse’s AT1s without reading the terms, and therefore failing to protect themselves against risk, they were idiots and deserve what they get -- nothing. For starters, if they misunderstand how something works that badly, how were they modeling it to calculate value and volatility?! "Sophisticated" financial players should be laughed out of the building for essentially saying "I didn't research what I was buying, and I just assumed they were like this other common thing."
- matthewdgreen 4y ago
  It can simultaneously be true that these investors were idiots, and also that there will be many fewer idiots available to purchase bonds in the future when you need them to.
  - ethbr0 4y ago
    2008 showed us what happens when idiocy and fraud become commonplace and without consequence. Better a few lose their shirts, such that others maintain a healthy dose of fear to motivate due diligence.
    - zpeti 4y ago
      Do you think the same about all the inner city minority people who got adjusted rate mortgages which all collapsed in 2008, some who couldn’t even read, and were conned by banks? Why didn’t they make sure they understood what they were getting into?
      - piva00 4y ago
        They weren't sophisticated financial investors, they were conned by big finance.
        ethbr0 4y ago
        Eh, little of column A, little of column B on the "conned." They were offered a contract, took it, got something (a home they probably couldn't afford), and then lost their home when rates exploded. "Conned" seems a little strong for agreeing to a bad contract. On the other hand, to the original point, it seems fair to expect bond traders to be more financially sophisticated than home buyers.
headsoup 4y ago
Ah the old having their cake and eating it too.
hibikir 4y ago
Both Levine here, and the Economist article we are all responding to, fail to look in extra detail at what happened in the Spanish situation with preferential shares/AT1s . Around 700K investors, mostly elderly looking for a safe investment in their retirement, were told that they were a very sure thing by the very same issuing banks that were advising them on what to buy. It was a great deal for the banks, which were not in the safest spot at the time, and knew that every sale was just lowering the institution's risk. When the banks really got in trouble, the retail AT1 investors were zeroed out, losing billions. But the story didn't end there. Cases went to trial, as investors claimed that they were deceived into buying instruments they didn't understand, by institutions that had a lot to gain by pushing them. Money was recovered in many cases, albeit many years later. I don't know the story of who bought CS' AT1s, but it'd not be surprising if we had a bonus chapter or two, just like in the Spanish equivalent, where regulators and judges have to choose between bankers and a non-trivial number of voters that considers themselves scammed, and can change their vote accordingly. Either way, It's not hard to see that this kind of instrument is not something that an unsophisticated retail investor should be buying, ever.
- JumpCrisscross 4y ago
  > were told that they were a very sure thing by the very same issuing banks that were advising them on what to buy Separate problems. One, a security issued by an issuer. The second, bad sale by a broker. That the broker is affiliated with the issuer is interesting, and I imagine everyone who bought CS AT1s is gearing up the lawsuit bazooka, but not super relevant to the zeroing out per se.
- lordnacho 4y ago
  I think a big problem is calling the thing a bond. Everybody is going to think it is senior to equity when in fact it's junior, because that's what every class in capital structure says: the most junior tranche is called equity. In general complicating things is not a great idea. Why didn't the regulators just say "hey you guys just need to issue more regular equity" instead of inventing this weird Frankenstein? Especially in a crisis, people need to be able to think quickly and clearly about what they have, and making things more complex does not help that.

dang 4y ago

Related: UBS got Credit Suisse for almost nothing - https://news.ycombinator.com/item?id=35236043 https://news.ycombinator.com/item?id=35236043 - March 2023 (117 comments)

JumpCrisscross 4y ago

TL; DR Swiss AT1 securities are unlike others. If the SNB said the right magic words first (CET1 < 7%), this is proper form.

NoboruWataya 4y ago
Not according to Levine, who points out that this write down is not a result of CET falling below 7%, but a separate clause in the bonds that kicks in where a regulator decides it needs to zero the bonds to prevent CS's insolvency. Other AT1s apparently do not have such clause, but that doesn't mean investors in those bonds are entirely safe from this ever happening to them. In the EU there is BRRD, which gives regulators extensive powers to resolve failing banks pretty much however they see fit. However, EU regulators have apparently put out a statement saying (basically) that they wouldn't do it this way and would let shareholders take the hit first. It's a little surprising to me that they would tie their hands like this, but I guess a lot of EU banks are heavily reliant on AT1 funding so they felt they had to do something to restore confidence.
- JumpCrisscross 4y ago
  > this write down is not a result of CET falling below 7%, but a separate clause in the bonds that kicks in where a regulator decides it needs to zero the bonds to prevent CS's insolvency That write-down to zero (versus automatic conversion) was front and centre makes the Swiss precedent limited, in my opinion. Nobody who ever trades AT1s will have public opinions about it. But from what I can tell, the rules were followed.
  - cjbgkagh 4y ago
    It’s only limited if everyone was informed before, and informed now. Given the market moves neither appear to be the case. The mere impression of the open ended risk is sufficient to cause contagion. People will be looking closer at the regulatory discretion clauses in bail in legislation and probably not liking what they see.
    - JumpCrisscross 4y ago
      > the market moves neither appear to be the case A significant amount of that movement is being driven by Asian retail. How they were sold these is another question. AT1s without write-down may be a smart buy at the moment.

nytesky 4y ago

Reminds me of auction rate securities and exchange traded notes. Seeming to have less risk, but with limited upside, and whoops worse downside.

ethbr0 4y ago

If counterparties bought Credit Suisse’s AT1s without reading the terms, and therefore failing to protect themselves against risk, they were idiots and deserve what they get -- nothing. For starters, if they misunderstand how something works that badly, how were they modeling it to calculate value and volatility?! "Sophisticated" financial players should be laughed out of the building for essentially saying "I didn't research what I was buying, and I just assumed they were like this other common thing."

matthewdgreen 4y ago
It can simultaneously be true that these investors were idiots, and also that there will be many fewer idiots available to purchase bonds in the future when you need them to.
- ethbr0 4y ago
  2008 showed us what happens when idiocy and fraud become commonplace and without consequence. Better a few lose their shirts, such that others maintain a healthy dose of fear to motivate due diligence.
  - zpeti 4y ago
    Do you think the same about all the inner city minority people who got adjusted rate mortgages which all collapsed in 2008, some who couldn’t even read, and were conned by banks? Why didn’t they make sure they understood what they were getting into?
    - piva00 4y ago
      They weren't sophisticated financial investors, they were conned by big finance.
      - ethbr0 4y ago
        Eh, little of column A, little of column B on the "conned." They were offered a contract, took it, got something (a home they probably couldn't afford), and then lost their home when rates exploded. "Conned" seems a little strong for agreeing to a bad contract. On the other hand, to the original point, it seems fair to expect bond traders to be more financially sophisticated than home buyers.

headsoup 4y ago

Ah the old having their cake and eating it too.

hibikir 4y ago

Both Levine here, and the Economist article we are all responding to, fail to look in extra detail at what happened in the Spanish situation with preferential shares/AT1s . Around 700K investors, mostly elderly looking for a safe investment in their retirement, were told that they were a very sure thing by the very same issuing banks that were advising them on what to buy. It was a great deal for the banks, which were not in the safest spot at the time, and knew that every sale was just lowering the institution's risk. When the banks really got in trouble, the retail AT1 investors were zeroed out, losing billions. But the story didn't end there. Cases went to trial, as investors claimed that they were deceived into buying instruments they didn't understand, by institutions that had a lot to gain by pushing them. Money was recovered in many cases, albeit many years later. I don't know the story of who bought CS' AT1s, but it'd not be surprising if we had a bonus chapter or two, just like in the Spanish equivalent, where regulators and judges have to choose between bankers and a non-trivial number of voters that considers themselves scammed, and can change their vote accordingly. Either way, It's not hard to see that this kind of instrument is not something that an unsophisticated retail investor should be buying, ever.

JumpCrisscross 4y ago
> were told that they were a very sure thing by the very same issuing banks that were advising them on what to buy Separate problems. One, a security issued by an issuer. The second, bad sale by a broker. That the broker is affiliated with the issuer is interesting, and I imagine everyone who bought CS AT1s is gearing up the lawsuit bazooka, but not super relevant to the zeroing out per se.
lordnacho 4y ago
I think a big problem is calling the thing a bond. Everybody is going to think it is senior to equity when in fact it's junior, because that's what every class in capital structure says: the most junior tranche is called equity. In general complicating things is not a great idea. Why didn't the regulators just say "hey you guys just need to issue more regular equity" instead of inventing this weird Frankenstein? Especially in a crisis, people need to be able to think quickly and clearly about what they have, and making things more complex does not help that.