When stockholders get paid before bondholders.

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Northern Flicker
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When stockholders get paid before bondholders.

Post by Northern Flicker »

Some Credit Suisse bondholders were moved to a position junior to stockholders in the deal put together for UBS to purchase Credit Suisse.
Ordinarily, bondholders are higher up the pecking order than shareholders when a banks fails. But because Credit Suisse’s demise has not followed a traditional bankruptcy, analysts told CNN, the same rules don’t apply.

“The hierarchy of claims remains applicable in the EU… there is no way that shareholders can be paid and AT1 holders [are] paid zero,” Benamou said. “The decision taken by the Swiss authorities is really very strange.”
Of course, Switzerland is not in the E.U.

https://edition.cnn.com/2023/03/20/inve ... index.html
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Ocean77
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Re: When stockholders get paid before bondholders.

Post by Ocean77 »

These are not regular bonds. They are of a special type that under certain conditions get worthless. Why somebody would put their money into these in the first place is beyond me.
30% US Stocks | 30% Int Stocks | 40% Bonds
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Northern Flicker
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Re: When stockholders get paid before bondholders.

Post by Northern Flicker »

European investment professionals were surprised by the move. Officials in the EU and UK re-assured investors in these types of bonds that stockholders would not be moved ahead of them. And legal action is planned. The question is not whether these bonds are risky and could go to zero, but whether they can be wiped out while stockholders preserve some equity.

I do wonder if most of the AT1 bonds are held by non-Swiss entities. That would highlight a risk of international investing.
Joey Jo Jo Jr
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Re: When stockholders get paid before bondholders.

Post by Joey Jo Jo Jr »

Northern Flicker wrote: Fri Mar 24, 2023 12:22 am The question is not whether these bonds are risky and could go to zero, but whether they can be wiped out while stockholders preserve some equity.
Whatever article I read about this suggested that’s exactly what the terms of the AT1 bonds allowed. I guess if you’re Switzerland you get to play that card one time so you might as well make it good.
Scorpion Stare
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Re: When stockholders get paid before bondholders.

Post by Scorpion Stare »

Matt Levine gave a simple explanation of how an AT1 works in a recent Money Stuff newsletter:
After the 2008 financial crisis, European banks issued a lot of what are called “additional tier 1 capital securities,” or “contingent convertibles,” or AT1s or CoCos. The way an AT1 works is like this:
  1. It is a bond, has a fixed face amount, and pays regular interest.
  2. It is perpetual — the bank never has to pay it back — but the bank can pay it back after five years, and generally does.
  3. If the bank’s common equity tier 1 capital ratio — a measure of its regulatory capital — ffalls below 7%, then the AT1 is written down to zero: It never needs to be paid back; it just goes away completely.
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.
And then he discussed why these are not like normal bonds:
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%. Like, imagine a bank:
  • It has $1 billion of assets (also $1 billion of regulatory risk-weighted assets).
  • It has $100 million of common equity (also $100 million of regulatory common equity tier 1 capital).
  • It has a 10% CET1 capital ratio.
  • It also has $50 million of AT1s with a 7% write-down trigger, and $850 million of more senior liabilities.
This bank runs into trouble and the value of its assets falls to $950 million. What happens? Well, under the very straightforward terms of the AT1s — not some weird fine print in the back of the prospectus, but right in the name “7% CET1 trigger write-down AT1” — this is what happens:
  • It has $950 million of assets and $50 million of common equity, for a CET1 ratio of 5.3%.
  • This is below 7%, so the AT1s are triggered and written down to zero.
  • Now it has $950 million of assets, $850 million of liabilities, and thus $100 million of shareholders’ equity.
  • Now it has a CET1 ratio of 10.5%: The writedown of the AT1s has restored the bank’s equity capital ratios.
This, again, is very explicitly the whole thing that the AT1 is supposed to do, this is its main function, this is the AT1 working exactly as advertised. But notice that in this simple example the bank has $950 million of assets, $850 million of liabilities and $100 million of shareholders’ equity. This means that the common stock still has value. The common shareholders still own shares worth $100 million, even as the AT1s are now permanently worth zero.
Though in the following newsletter he talks more about the specifics of the Credit Suisse case. Rather than Credit Suisse zeroing its AT1s through their built-in triggering mechanism, the AT1s were zeroed by the banking regulator as part of its larger action to save the bank. Bank rescues in general take place in a sort of legal no-man's-land where normal procedures are frequently tossed out the window.
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Northern Flicker
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Re: When stockholders get paid before bondholders.

Post by Northern Flicker »

These Reuters article have some more info:
https://www.reuters.com/markets/why-markets-are-uproar-over-risky-bank-bond-known-at1-2023-03-24/ wrote: AT1s rank higher than shares in the capital structure of a bank. If a bank runs into trouble, bondholders will rank above shareholders in terms of getting their money back.

In Switzerland, the bonds' terms state, however, that in a restructuring, the financial watchdog is under no obligation to adhere to the traditional capital structure, which is how bondholders lost out in the Credit Suisse situation.
and:
https://www.reuters.com/markets/europe/swiss-regulator-gives-information-about-credit-suisse-bond-write-down-2023-03-23/ wrote: "The AT1 instruments issued by Credit Suisse contractually provide that they will be completely written down in a 'viability event', in particular if extraordinary government support is granted," FINMA said
I guess for investors in a DM or total ex-US equity index fund, the Swiss govt's handling of this was a good thing, although I don't think Credit Suisse equity investors got much.

AT1 bonds have similarities to preferred stock (but apparently can be "un-preferred" in Switzerland).

I think EU regulators are worried about the cost of banks financing liabilities through debt issue and sought to re-assure markets.
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Re: When stockholders get paid before bondholders.

Post by patrick »

Northern Flicker wrote: Fri Mar 24, 2023 12:22 am European investment professionals were surprised by the move. Officials in the EU and UK re-assured investors in these types of bonds that stockholders would not be moved ahead of them. And legal action is planned. The question is not whether these bonds are risky and could go to zero, but whether they can be wiped out while stockholders preserve some equity.

I do wonder if most of the AT1 bonds are held by non-Swiss entities. That would highlight a risk of international investing.
It is a benefit to those of us, myself included, who hold international stock index funds. Those funds included Credit Suisse in their holdings. It is a small fraction to be sure, but every penny counts.

I doubt the risk hit many of us because international bond funds seem to be less popular here. Furthermore, while I haven't checked, I presume the main international bond indexes exclude this type of bond.
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Northern Flicker
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Re: When stockholders get paid before bondholders.

Post by Northern Flicker »

In this case, yes. But when bankruptcies, frauds, or other distress situations are dealt with by other countries, foreign investors may be at the mercy of the other government and its courts.
Weathering
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Re: When stockholders get paid before bondholders.

Post by Weathering »

I've seen instances where bondholders get less than full par value, yet the stockholders get more than $0.00/share. This happens when an agreement is trying to be reached quickly to move a failing company forward into bankruptcy. Frequently, when this occurs, a major stockholder has agreed to put in new investment into the company while they are going through the bankruptcy proceeding. They threaten that without their new investment, the company will be liquidated. So, the major bondholders agree to take the haircut.
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Northern Flicker
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Re: When stockholders get paid before bondholders.

Post by Northern Flicker »

The bondholders having to agree to a restructuring was still putting them ahead of stockholders. The senior position is why they had to be asked and agree.
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jeffyscott
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Re: When stockholders get paid before bondholders.

Post by jeffyscott »

Scorpion Stare wrote: Fri Mar 24, 2023 10:30 am Though in the following newsletter he talks more about the specifics of the Credit Suisse case. Rather than Credit Suisse zeroing its AT1s through their built-in triggering mechanism, the AT1s were zeroed by the banking regulator as part of its larger action to save the bank. Bank rescues in general take place in a sort of legal no-man's-land where normal procedures are frequently tossed out the window.
So it seems that even though it may have happened in a different way than specified in the prospectus, etc., the fund managers at PIMCO, etc. that chose to buy these things (and are now suing), knew or should have known that this was a possible outcome.
exodusing
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Re: When stockholders get paid before bondholders.

Post by exodusing »

Based on Matt Levine's newsletter, the prospectus for these AT1 bonds explicitly stated that they may come behind equity in some cases. The explicit triggering formula for being junior to equities may or may not, have been met in this case, but the bondholders should not have been surprised that they are behind equity in a situation in which Credit Suisse was on the verge of insolvency, if not over the edge. I'm not sure if how the prospectus covered the case of regulatory intervention in case the formula was not met, but perhaps there was a statement about being subject to the laws and regulations covering CS.

There are many analyses of the situation by those who have not bothered to read the prospectus and governing documents. There are many stories pushed by bondholders and their representatives who have a definite interest in the issue. The CS AT1s appear to be highly unusual.
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