A question that many people have been asking themselves these days due to the collapse of Credit Suisse, what are AT1 bonds?
Literally means “Additional Tier1” for AT1 experts, it is an element not to be underestimated because it demonstrates the risk of banking instability that we are experiencing in this period (March 2023) with the risk of contagion on a global scale (Credit Suisse, Silicon Valley Bank etc …).
AT1 bonds are financial debt instruments with a lower credit rating that a bank can issue.
They have the function of participating in the absorption of losses of the bank if the capital ratios fall below a certain level. We could define it as a cushion and were created during the 2008 subprime mortgage financial crisis (see Lehman Brothers) to avoid the need for bailouts of government-funded banks.
AT1 bonds do not mature because they are perpetual with the possibility of early repayment by exercising a call option (derivatives) with the function (as mentioned above) of absorbing losses.
When the bank has no accounting problems, these AT1 have the normal function like the classic bonds or those who bought them will receive interest on the credit and repayment on the maturity date.
In the event of a deterioration in the solvency position, coupons are cancelled or the principal is temporarily or permanently converted into bank shares by reducing the issuer’s debt (absorbing losses).
AT1 bonds have the same characteristics (risks) as any fixed income issuer such as issuer risk, rising interest rates or, as is happening in March 2023, the risk of non-repayment.
AT1 bond yield?
These bonds offer high yields (high gains = high risks) depending on the level of subordination of these securities in the investment capital structure.