Credit Suisse And The AT1 Fallout: Why Investors Were Left With Nothing

The collapse of Credit Suisse in early 2023 sent shockwaves through global financial markets, but one of the most controversial aspects of the crisis was the unprecedented wipeout of $17 billion in Additional Tier 1 (AT1) bonds.

AT1 bonds, introduced after the 2008 financial crisis, were designed as a safeguard, allowing banks to raise capital while absorbing losses in times of distress. However, the Credit Suisse debacle revealed fundamental flaws in AT1s, particularly their unpredictable treatment in banking crises. Investors who had viewed AT1 bonds as a relatively stable high-yield instrument were blindsided when Swiss regulators overrode traditional creditor hierarchies, leaving bondholders with nothing while equity investors were protected.

This event raised critical questions about the risks of AT1 bonds, their role in financial stability, and whether they should continue to exist in their current form.

What Are AT1 Bonds and Why Do Banks Use Them?

Definition and Purpose

AT1 bonds, also known as contingent convertible (CoCo) bonds, are a class of hybrid debt instruments introduced as part of post-2008 banking reforms. They allow banks to raise capital and absorb losses during financial distress without requiring taxpayer-funded bailouts.

AT1 bonds differ from traditional debt in several ways:

• They pay high yields, making them attractive to investors.
• They are perpetual, meaning banks are not obligated to repay them.
• In a crisis, they can be converted into equity or written down, helping banks restore their capital buffers.

How AT1s Work in Theory

The primary function of AT1s is to act as a shock absorber, transferring risk from governments and depositors to investors. If a bank faces financial trouble, AT1 holders are supposed to take losses before senior debt holders but after shareholders—at least in theory.

Credit Suisse Collapse: The AT1 Controversy

The Bank’s Decline

Credit Suisse’s troubles were years in the making, stemming from scandals, mismanagement, and declining investor confidence. A series of financial and reputational blows—including involvement in Greensill Capital’s collapse, Archegos Capital’s implosion, and money-laundering allegations—drove depositors and investors away.

The crisis accelerated after the failure of Silicon Valley Bank (SVB) in March 2023, triggering panic across the banking sector. Credit Suisse suffered massive deposit outflows, forcing Swiss regulators to step in to prevent a full-scale collapse.

The Swiss Government’s Unprecedented Move

To stabilize the situation, Swiss authorities forced a takeover of Credit Suisse by UBS. However, in a highly controversial decision, regulators wiped out $17 billion in AT1 bonds while allowing Credit Suisse equity investors to retain some value.

This move defied the traditional creditor hierarchy, where bondholders are typically prioritized over shareholders in a crisis. Investors who had believed AT1s were a step above equity in risk exposure were left with nothing.

Why This Was Unprecedented

• In previous bank rescues, AT1s were either converted to equity or given some residual value—not completely erased while stocks retained worth.
• The Swiss authorities’ discretionary decision-making highlighted that AT1 bondholders had far less protection than they previously assumed.
• This incident shattered confidence in AT1 bonds, triggering widespread panic in global credit markets.

Market Reaction and Investor Fallout

Immediate Market Impact

The Swiss government’s move shocked global bond markets:

• AT1 bonds from other banks were heavily sold off, as investors feared similar treatment in future crises.
• Borrowing costs for European banks surged, as investors demanded higher risk premiums.
• Financial institutions faced difficulties in issuing new AT1 instruments, limiting their ability to raise capital.

Legal and Regulatory Scrutiny

• Investors launched lawsuits against Swiss regulators, arguing that the AT1 wipeout violated contractual protections.
• The European Central Bank (ECB) and UK regulators quickly reassured markets that, under their jurisdiction, AT1 bonds would be treated in accordance with standard creditor hierarchies to prevent further panic.
• These reassurances helped stabilize markets but did little to restore long-term investor trust in AT1 bonds.

Loss of Confidence in AT1s

• Banks faced greater difficulty issuing new AT1 bonds, forcing them to explore alternative ways to raise capital.
• The episode eroded trust in regulatory consistency, as governments appeared willing to rewrite rules in a crisis.
• Many investors reassessed their risk exposure to AT1s, viewing them as far more unpredictable than previously thought.

What the Credit Suisse Crisis Taught Us About AT1s

Lack of Standardization

The Credit Suisse case exposed a fundamental problem: AT1 treatment varies by jurisdiction, creating uncertainty about how they will be handled in future crises.

• Swiss AT1 bonds were structured to allow complete write-downs, while other countries provide clearer protections for bondholders.
• This inconsistency increases market risk, making AT1s a less reliable capital buffer.

Regulatory Arbitrary Decision-Making

The Swiss government’s handling of Credit Suisse raised concerns about regulators overriding market rules in emergencies.

• If governments can wipe out AT1s at will, investors will demand higher risk premiums, making it more expensive for banks to raise capital.
• Unpredictability discourages long-term investment in AT1 bonds, reducing their effectiveness as a financial stability tool.

AT1 Bonds Are Riskier Than Advertised

The Credit Suisse collapse shattered the assumption that AT1s provide a clear risk hierarchy:

• The event proved that AT1 holders could lose everything before shareholders, contradicting their original purpose.
• Many investors who previously viewed AT1s as a relatively stable, high-yield asset now see them as extremely volatile.

The Future of AT1 Bonds: Should They Be Phased Out?

Can AT1s Be Reformed?

To restore investor confidence, AT1s would need:

• Stronger legal protections to prevent arbitrary write-downs.
• Harmonization of AT1 rules across jurisdictions to ensure consistent treatment.
• Greater transparency from regulators on how AT1s will function in future crises.

Alternatives to AT1s

If AT1 bonds prove too unreliable, banks may need to shift toward:

• Stronger core equity capital requirements rather than hybrid instruments.
• More traditional subordinated debt, which follows standard bankruptcy procedures.

Will Banks Continue to Use AT1s?

Despite their flaws, AT1s remain attractive to banks because they allow for capital flexibility and regulatory compliance. However, if investor confidence does not return, AT1s may become too expensive or ineffective as a capital-raising tool.

Conclusion

The Credit Suisse collapse exposed serious flaws in the AT1 bond system, raising questions about their future.

• Investors learned that AT1 bonds carry far greater risks than previously understood.
• Regulators demonstrated their willingness to rewrite the rules, undermining trust in the financial system.
• While AT1s were meant to enhance financial stability, they may have instead contributed to market chaos.

The key takeaway: If AT1 bonds are to survive, they need fundamental reforms. Otherwise, financial institutions must find better tools to strengthen their capital buffers without creating unpredictable investor risks.

Author: Brett Hurll