Loss-absorbing subordinated debt
A perpetual instrument paid like a bond but written down or converted ahead of shares, funding regulatory capital without diluting shareholders.
March 19, 2023: FINMA orders the full write-down of Credit Suisse's CHF 16 billion of AT1, while shareholders receive CHF 3 billion in the UBS takeover. The order in which losses are absorbed does not always follow the order of the balance sheet. Loss-absorbing subordinated debt is a perpetual instrument with no redemption date. The issuer may cancel the coupon at its discretion, and the principal is written down or converted into shares once a regulatory trigger is breached. It appeals to the issuer in two ways. It counts toward the highest tiers of regulatory capital while remaining debt for tax purposes in many jurisdictions, and issuing it does not dilute shareholders immediately. For the investor, the yield pays for a poorly understood risk, because the subordination runs deeper than the word debt suggests. Two features regularly catch the market out. Coupon cancellation is not a default and triggers no contractual remedy. And the loss absorption order may, depending on the governing texts, place these instruments behind shares that were assumed to be riskier. For an insurer they are one link in the financing of the capital requirement, and their refinancing cost reacts to credit spreads far more violently than senior debt.
On 19 March 2023, as part of the UBS takeover of Credit Suisse, the Swiss supervisor ordered the complete write-down of roughly sixteen billion Swiss francs of additional tier 1 capital instruments, while shareholders received UBS shares.
Follow the research
One letter a week. First, the week's underwriting note, when one is published: a dated, argued decision, signed by Paul Bernardski. Then what the observatory published on cyber risk, political risk and insurance. No account, no tracking.
No spam, one-click unsubscribe, no data ever sold.