No. of Recommendations: 5
More about these AT1's from Matt Levine:
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).[6]
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.
The AT1s are junior to the common stock. Not all the time, and there are scenarios (instant descent into bankruptcy) where the AT1s get paid ahead of the common. But the most basic function of the AT1 is to go to zero while the bank is a going concern with positive equity value, meaning that its function is to go to zero before the common stock does.
