The Swiss authorities’ full write-down of Credit Suisse Group AG (CS) Additional Tier 1 (AT1) notes, while not imposing full losses on its equity, is not regarded by Fitch Ratings as a global crisis management template for troubled banks. Major regulators have rushed to issue statements highlighting their intention to abide by the hierarchy of claims in liquidation. In the short term, however, the Swiss authorities’ actions highlight that AT1s are in the firing line for privatizing bank losses, which will sharpen technical scrutiny of existing hybrids’ contractual terms, and may result in higher risk-adjusted pricing and lower issuance.
 
Questions remain if recent events will affect Swiss banks’ future access to these markets, and to what extent issuance dries up amid waning investor appetites. The fast-moving nature of bank failures and the potential for ambiguity in authorities’ decision-making process means that investors will likely continue to assess their options for redress if AT1s absorb losses.
 
AT1s are designed to be converted to equity or written down in accordance with their contractual terms if capital levels of issuing banks fall below required levels to absorb losses or in a resolution scenario. The AT1 instruments issued by CS contractually provided they will be completely written down in a “Viability Event,” in particular if extraordinary government support is granted. As CS was granted extraordinary liquidity assistance loans secured by a federal default guarantee on 19 March 2023, the Swiss Financial Market Supervisory Authority (FINMA) judged the “Viability Event” was triggered and so fully and permanently wrote off CHF15.8 billion (USD17.3 billion) of CS’s AT1 capital. In addition, the Federal Council enacted an Emergency Ordinance on March 19, 2023 that authorized FINMA to write down AT1 for banks receiving this type of liquidity line.
 
The Swiss authorities’ actions illustrate that regulatory intervention can be swift, and that authorities’ crisis management toolkits can broaden if a bank is deemed systemic. Following FINMA’s actions, the EU, UK, Canadian, Hong Kong and Singaporean authorities highlighted they would adhere to the conventional creditor hierarchy and impose losses first and fully on equity before then moving to subordinated creditors. Nevertheless, the recent episode highlights that AT1s are usually in the firing line when authorities impose losses onto private creditors of troubled banks, and face poor recovery prospects in a write-down or conversion scenario, in line with the two notches we apply for loss severity as part of our four-notch baseline notching for AT1s.
 
The USD250 billion AT1 market remains important to banks’ qualifying capital, particularly in order to meet leverage ratio. Western European banks have a higher reliance on hybrid debt than in North America, where AT1 contingent convertible capital instruments are not eligible as Tier 1 capital for US banks. AT1s make up a growing proportion of Asia-Pacific banks’ capital, particularly for systemic Chinese banks to meet TLAC needs.
 
Increased scrutiny regarding the Basel capital buffer system’s usability has led to calls, mostly from German and UK supervisors, for a capital stack redesign, with greater emphasis on a simpler but thicker common equity tier 1 (CET1) buffer that can be more readily be pierced. However, in the short-to-medium term it is unlikely that any substantial changes to AT1’s eligibility within the bank capital regime will change.
 
In the medium term however, Fitch expects pressure on AT1 issuance to reflect further regulatory debate on the continued role as going-concern capital (particularly low-trigger instruments), and from pricing due to the higher yields that issuers may need to offer to the market. UK and Switzerland instruments are high trigger only.
 
AT1 and T2 debt, along with senior holding company and senior ‘non-preferred’ debt, more commonly benefit bank senior (preferred) debt ratings via their capacity to recapitalise a bank. The principle of gone-concern resolution debt buffers seems likely to endure, irrespective of what happens to AT1 and T2 debt.