Everything You Need to Know About AT1s
What are AT1s?
- Definition: Additional Tier 1 bonds (AT1s) are a type of bank capital securities known as contingent convertibles or Cocos.
- Convertible: Can be converted into equity or written down.
- Contingent: Conversion occurs if issuing bank’s capital falls below a trigger level.
- Key Feature: Loss absorbing mechanism, leading to higher yields than regular bonds.
Why do Banks Issue AT1s?
- Post-2008 Financial Crisis: Regulators increased capital requirements for banks.
- Basel III Framework: Banks must hold a minimum 4.5% CET1 capital ratio and an 8% total capital ratio.
- National regulators often require higher than global minimums.
- Capital Supplementation:
- 1.5% of RWAs in AT1 capital.
- 2% in tier two capital.
- Market Development: US uses preference shares; Europe developed specific AT1 bonds in 2013.
How do AT1s Work?
- Three Basic Features:
- Loss Absorbing Mechanism: Triggered when CET1 ratio falls below threshold (5.125% or 7%).
- Perpetual Nature: No maturity, callable with approval.
- Non-call periods: 5 to 10 years.
- Coupon resets if not called.
- Non-cumulative, Discretionary Coupons: Missed payments are not default events.
What are the Risks?
- Capital Deterioration: CET1 ratio falling below trigger level affects bondholders.
- Large banks typically have CET1 ratios much higher than trigger levels.
- Extension Risk: Banks may not call AT1 bonds, retaining them as capital indefinitely.
- Coupon Risk: Regulators can halt AT1 coupons under the Maximum Distributable Amount (MDA) rule.
- History shows preference for halting dividends and bonuses first.
What is the Point of Non-Viability?
- Regulatory Discretion: Bank solvency assessed by national regulators or the European Central Bank.
- Preventive Measures: Declaration to protect depositors and prevent contagion before reaching AT1 trigger levels.
- Investor Considerations:
- Awareness of individual bank capital requirements.
- Importance of stress tests.
Source: European Central Bank Press Release