AT1 bonds: what are they? Why are they causing a stir these weeks?

There is an acronym that many people did not know until a few months ago and that has filled the financial headlines in recent weeks. We are talking about the acronym AT1 (which stands for Additional Tier 1) and which goes with a type of bonds issued by banks. Their 'fame' grew a lot as soon as the Swiss banking giant Credit Suisse ended up on the brink of the abyss and was rescued by its competitor Ubs, which will take over its assets under the direction of the Swiss financial authorities. In the Credit Suisse rescue operation, the value of the AT1 bonds was wiped out and those who owned them saw their capital go up in smoke, thus suffering worse treatment than those who held shares (who instead suffered losses of more than 70% but still did not lose all their capital).

 

They are debt securities issued by banks, which, unlike other bonds, have no maturity date. They are therefore referred to as perpetual bonds, even though they can be redeemed by the issuing bank in advance. In the event of the bankruptcy of the institution that issued them, At1 bonds can be converted into shares (thus endowing the bank with additional capital) or see their value reduced to zero, as in the case of Credit Suisse. At1 bonds are therefore riskier securities than ordinary bonds. This is why they are classified as junior bonds (to distinguish them from ordinary bonds, which are instead 'senior'). Being riskier than junior bonds, AT1 bonds are obviously also much more profitable in terms of interest.

 

Normally, bond holders (of whatever nature) are never penalised compared to shareholders: "Credit Suisse's AT1 bonds were cancelled due to a distortion in the hierarchy of capital redemption requests implemented by the Swiss Federal Market Supervisory Authority (FINMA) that favoured shareholders over holders of this type of bond," explains Corrado Cominotto, head of Active Asset Management at Banca Generali, who adds: "We do not believe that what happened to Credit Suisse could also happen in Europe or on other continents. In Europe," as Cominotto explains, "the regulator clearly stipulates that common equity instruments (e.g. ordinary shares) are the first to absorb any losses incurred by the bank and only then can recourse be made to capital issued through AT1". This rule was officially confirmed on the Monday following the Credit Suisse collapse, to reassure investors and dispel doubts about the possibility of a similar event.

That being said, it is, however, wrong to lump AT1 bonds together and consider them securities to be avoided. "These days we are beginning to see selective buying opportunities," Cominotto concludes, "the AT1 segment, which has particularly attractive yields, will still remain a source of volatility. From a fundamental point of view, however, the main European institutions are showing solidity at the highest levels in recent years". Given the complexity of this asset class, however, for Cominotto the use of asset management, with the help of professionals, is indispensable.