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Credit FAQ: Asia-Pacific AT1 Hybrids Investors: Understanding The Credit Suisse Fallout


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Credit FAQ: Asia-Pacific AT1 Hybrids Investors: Understanding The Credit Suisse Fallout

Asia-Pacific investors are not alone in questioning how the recent global banking turmoil will affect the region. And additional Tier 1 hybrid securities are most on their minds. S&P Global Ratings addressed these concerns at its webinar on March 22, 2023. During the session, our analysts and economists discussed key risks for banks in the aftermath of regional bank failures in the U.S., volatility around European banks, and the macroeconomic ramifications.

We also talked about the government-facilitated takeover by UBS of Credit Suisse Group AG. Asia-Pacific investors want to understand the effects of the write-down to zero of Credit Suisse's Swiss franc 16 billion AT1 portfolio. They also want to know our rating views on various aspects of this write-down and the implications for the Asia-Pacific bank AT1 hybrids market.

This article answers key questions on Asia-Pacific bank AT1 instruments, and complements our commentary on Credit Suisse and UBS. (See "European Bank AT1 Hybrids In A Post-Credit Suisse World," March 21, 2022, and "Swiss Regulator's Statement On Credit Suisse AT1 Confirms Impact Of Documentation And Legislative Powers," published on RatingsDirect on March 23, 2023.)

Frequently Asked Questions

If AT1 investors in an Asia-Pacific bank were to bear losses before, or to a greater extent than, common equity shareholders, would S&P Global Ratings react differently compared with how it reacted to the Credit Suisse situation?

No. It's unlikely that our AT1 rating reaction would differ to our views outlined in our commentary on Credit Suisse (see "European Bank AT1 Hybrids In A Post-Credit Suisse World," March 21, 2023). Our hybrids rating criteria and guidance is globally applicable.

Many market participants had not anticipated that the Swiss authorities would enforce a 100% write-down of the AT1 instruments without also wiping out common equity shareholders. But the AT1 documentation, combined with the authorities' legislative powers, made this outcome possible. If the same scenario occurred for an Asia-Pacific bank issuer, our view of the impact on AT1 ratings would broadly be the same.

Are AT1 instruments issued by Asia-Pacific banks likely to be written off in the same manner as in the Credit Suisse case?

Under the Credit Suisse outcome, AT1 instruments were written down permanently to zero even though common equity shares were not. We don't believe the Credit Suisse outcome for AT1 instruments is an automatic template for Asia-Pacific banks to follow. For example, on March 22, 2023, the Hong Kong Monetary Authority announced that holders of capital instruments issued by a financial institution should expect to be treated in resolution in accordance with the priority they would enjoy on a winding-up of the institution. As such, shareholders would be the first ones to absorb losses, followed by holders of AT1 and Tier 2 capital instruments.

Similarly, European and U.K. authorities highlighted that common equity is junior to AT1 instruments in the creditor hierarchy in their jurisdictions. We note, however, that Asia-Pacific resolution frameworks could enable the write-down to zero of AT1 instruments with principal write-down features if a bank were to enter a formal resolution process. Some instrument structures allow for a temporary write-down while some may allow the resolution authorities to impose a partial write-down. We note that even in a situation where a bank is not in a resolution process, AT1 instruments will typically be written down or converted into common equity, depending on the documentation, if the bank's common equity Tier 1 (CET1) ratio hits a 5.125% trigger.

Do Asia-Pacific AT1 instruments use conversion or write-down features?

This varies by jurisdiction depending on regulator and investor preferences. For example, in Australia, the terms of listed banks' AT1 instruments (or banks with listed parents) typically state that these instruments would convert into common equity in a loss-absorption or a nonviability event. Although the regulation allows both conversion and write-off. By contrast, Indian banks' AT1 terms typically stipulate write-off. However, regulations in India allow both options. In Japan, terms and conditions of banks who already issued AT1 (not rated by us) state the instruments would write-down if 1) Commencement of bankruptcy or insolvency process, 2) When the point of non-viability event (PONV) occurred, 3) Loss absorption event occurs, more specifically, when CET1% is estimated by the authorities less than 5.125%, while regulations in Japan also allow both conversion and write down options.

The Credit Suisse AT1 write-down is causing investors to reassess fundamental concepts such as write-down versus conversion. What is the rating implication of a bank choosing one feature over another?

Some investors have historically sought to hold write-down AT1s rather than conversion AT1s. This is because they may be reluctant or unable to hold instruments that are mandatorily convertible into common equity in their portfolios.

A conversion into common equity in a time of stress may often involve a hit to the AT1 investor, who may receive shares worth less than the principal value of the AT1. This may involve considerable added downside in many circumstances, even where a fixed-income investor would not be a forced seller of any equity stake.

The Credit Suisse AT1 instruments had a full and permanent write-down feature. Many AT1 instruments do not have automatic write-downs to zero. Rather, for many AT1 instruments the documentation can often allow for a partial or "as needed" write-down. These can, in theory, enable a write-down that is lower than 100%.

We anticipate resolution authorities would act cautiously when deciding how much to write down the principal in such a case. This is because it could be unwieldy to come back to write down a larger portion if the bank has not stabilized. Therefore, we anticipate the authorities may write down as much as they determine might reasonably be required rather than the bare minimum they consider will definitely be required.

To what extent can you predict Asia-Pacific authorities' treatment of AT1 in the event of bank stress?

Exact outcomes can sometimes be difficult to predict. This is especially the case in Asia-Pacific where bail-in concepts have not been widely tested. When a bank is under stress the factual circumstances are idiosyncratic and depend on the magnitude and nature of the problem and the consequences if it is not solved. Further, bank regulators and public authorities maintain significant clout in normal times but have typically even more clout in stressful times. Regulators and public authorities have considerable powers and a range of tools at their disposal.

How will the Credit Suisse write-down affect banks' issuance in Asia-Pacific?

The Credit Suisse outcome has highlighted downside risk for AT1 investors in Asia-Pacific. The AT1 market is not immune to disruption, and in the past has been closed for several months at a time. We anticipate that Asia-Pacific Banks' AT1 issuance will become more expensive. For some, issuance will become more difficult. The impact will vary by jurisdiction and by issuer. The 100% write-down of the Credit Suisse AT1 reminds investors of the vulnerability of such instruments if a bank gets into trouble, and the influence of decisions by regulators and public authorities.

Have there been any rating changes to AT1 instruments issued by Asia-Pacific banks? Are any expected, particularly in the wake of the recent stress affecting the U.S. regional bank sector and Credit Suisse?

No AT1 ratings have been affected. And we don't expect broad-based rating changes to AT1 instruments issued by Asia-Pacific banks directly affected by these stresses--unless, of course, there is a significant escalation of contagion effects from recent banking events in the U.S. regional bank sector and Credit Suisse.

The ratings on senior unsecured obligations issued by many systemically important commercial banks based in Asia-Pacific have an uplift for the potential benefit of extraordinary government support. Do you expect any AT1 instruments issued by these banks to benefit from similar support?

We don't expect any AT1 instruments issued by any Asia-Pacific banks to benefit from extraordinary government support if it were needed. Rather, we anticipate these instruments will bear losses if needed to buffer senior unsecured creditors. Reflecting these higher risks, our ratings on AT1 instruments issued by Asia-Pacific banks are typically rated at least four notches lower than their issuing bank's stand-alone credit profile. Further, they are typically rated more than four notches lower than the issuer credit ratings.

What is the extent of holdings by Asia-Pacific banks in AT1 instruments issued by Credit Suisse? Is there downside risk for the investment portfolio of Asia-Pacific banks holding AT1s issued by U.S. and European banks?

We believe that the direct exposure of Asia-Pacific banks to Credit Suisse AT1 instruments is negligible. More generally, we note that banks typically have disincentives under regulatory capital rules from investing in other banks' regulatory capital (such as AT1s).

Credit Suisse Group's AT1 ratings were lowered to 'D'. Why doesn't the issuer credit rating on the issuer move to 'D' or 'SD'?

We move an AT1 issue credit rating to 'D' in the following circumstances: when the principal is written down, or it converts into common equity worth less than the face value, or a coupon is not paid, or if it is subject to a restructuring that we consider to be distressed.

Importantly, a 'D' on the issue credit rating on a regulatory capital instrument (such as an AT1) does not lead to a 'D' or 'SD' on the issuer credit rating of the issuing bank under our rating definitions. This reflects that the "bail-in" of a regulatory capital instrument such as an AT1 instrument can contribute toward a lower default risk for the senior obligations of an issuer. The issuer credit rating on the issuer reflects our view of default risk on the senior financial obligations of the issuer.

Is there a notching difference for an AT1 instrument that has write-off features versus one with conversion features?

Under our rating criteria, we deduct at least one notch for a mandatory contingent capital clause--whether it involves a principal write-down or a conversion into common equity. This is because many such mandatory conversions would be into common equity that could at the time either be worth less than the original hybrid's face value or that could itself be wiped out or subject to additional losses.

We want to ensure such a risk is always reflected in the rating--even if it's a conversion clause rather than a write-down clause. Further, we have the capacity under our criteria to deduct additional notches to reflect higher potential for AT1 investors to bear losses, if and where this may be warranted. This could be used to distinguish an AT1 with a conversion feature from those with a write-down feature, if we see a difference in default risk based on the specific circumstances of the instruments and bank.

Do Asia-Pacific banking resolution regimes specifically lay out the order of bail-in instruments? For instance, common equity Tier 1 capital to be wiped out first, then AT1, followed by Tier 2 and total loss absorbing capacity (TLAC)?

Resolution regimes are typically clear that common equity ranks below additional Tier 1, in the event of a resolution, which itself ranks below Tier 2 and then TLAC. This relates to the formal creditor hierarchy. This means that AT1 investors should typically not lose a higher percentage than equity investors in a resolution.

However, there can be situations where this doesn't quite hold true if a resolution doesn't take place. For example, if the payment on an AT1 issue is stopped, then the investor will never get that skipped coupon back because the coupons are noncumulative. In contrast, an equity investor could receive a higher dividend in the future to compensate for having missed a dividend (or for undergoing a reduced dividend in the past). The AT1 investor bears no upside.

We also see some AT1 instruments with mandatory high triggers whereby a breach of a specified regulatory capital ratio leads to an automatic hit to AT1 investors, even though shareholders might not bear any hit at all. For example, many of the Credit Suisse AT1 hybrids contained a clause that led to a mandatory permanent write-down of the principal to zero if the CET1 ratio fell below a specified "going-concern" number.

For example, many of the Credit Suisse AT1 hybrids contained a clause that led to a mandatory permanent write-down of the principal to zero if the CET1 ratio fell below a specific "going-concern" number of 7.00%. These 'high trigger' instruments are mostly not found in Asia-Pacific. They have mainly been issued in jurisdictions such as Switzerland but there are also some in other parts of Europe. Asia-Pacific instruments do typically however have triggers requiring write-down or conversion into common equity, depending on the documentation, if the relevant CET1 ratio falls below 5.125%.

In which banking jurisdictions do you believe there could be a pre-emptive public injection of capital without triggering a point of nonviability (PONV) event?

In Asia-Pacific, the main jurisdictions where we see this as a distinct possibility are Japan and Korea.

In many other countries--both regionally and globally--a pre-emptive capital injection could occur without triggering a PONV and formal resolution process. It's important to note that the Swiss authorities did not announce a PONV situation and did not instigate a formal resolution process for Credit Suisse. The announced transaction was a market-based solution that did not involve Credit Suisse entering into a resolution. At the same time, the Swiss authorities were still able to announce a principal write-down for the Credit Suisse AT1 instruments that are part of the regulatory going-concern capital buffer.

Editor: Lex Hall

Related Research

Related Criteria And Guidance

This report does not constitute a rating action.

S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).

Primary Credit Analyst:Gavin J Gunning, Melbourne + 61 3 9631 2092;
Secondary Contacts:Sharad Jain, Melbourne + 61 3 9631 2077;
Ryoji Yoshizawa, Tokyo + 81 3 4550 8453;
Geeta Chugh, Mumbai + 912233421910;
Ryan Tsang, CFA, Hong Kong + 852 2533 3532;
Daehyun Kim, CFA, Hong Kong + 852 2533 3508;
Michelle M Brennan, London + 44 20 7176 7205;
Alexandre Birry, London + 44 20 7176 7108;

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