AT1 CoCos and Bank Capital Securities
Banks issue a special class of bond designed to disappear or convert into equity exactly when the bank is in trouble — a feature that makes it high-yielding and, as one 2023 collapse showed, riskier than its ranking on paper suggests.
Prerequisites: Seniority and the Capital Stack, Credit Spreads
Since the 2008 crisis, regulators have required banks to hold layers of capital designed to absorb losses before taxpayers or depositors do. The most aggressive of these layers is Additional Tier 1 (AT1) capital, usually issued as bonds nicknamed CoCos — contingent convertibles. They pay a bond-like coupon in normal times, but they are built to convert into equity, or simply be written down to zero, automatically, the moment the bank's capital falls below a pre-set trigger — with no bankruptcy filing and no court process required.
A CoCo behaves like a normal high-yield bond until a bank's capital ratio breaches a trigger, at which point it converts to equity or is written down to zero by the terms of the security itself — not by a court, and not necessarily in the order you'd expect relative to the bank's actual shareholders.
What the trigger does
Every AT1 CoCo specifies a trigger, typically a Common Equity Tier 1 (CET1) ratio — the bank's core capital divided by its risk-weighted assets — falling below a level like 5.125% or 7%. Breach it, and the bond's terms activate automatically: some CoCos convert into a set number of new shares, diluting existing shareholders and giving CoCo holders an equity stake; others are simply written down, partially or fully, with no equity received in return at all.
Worked example
An investor holds $1 million face value of a bank's AT1 CoCo, trigger set at CET1 of 5.125%, structured as a full write-down (no equity conversion). The bank's CET1 ratio is currently 9%, and the bond trades near par, yielding 7% versus a senior unsecured bond from the same bank yielding 3%. That 4-point spread compensates for exactly this: the CoCo pays extra yield in exchange for bearing a loss the moment the trigger is crossed, well before the bank would ever file for any formal insolvency process.
If a sudden capital shock drives CET1 down to 4%, breaching the trigger, the $1 million position is written down to zero automatically, per the bond's terms — a complete loss with no court proceeding, no vote, and critically, potentially before the bank's common shareholders lose everything, since a write-down (rather than conversion) can leave equity holders with some residual value while AT1 holders are wiped out.
What this means in practice
That last point is exactly what happened in 2023 when Swiss regulators ordered a full write-down of a major bank's roughly $17 billion of AT1 bonds as part of an emergency rescue, while the bank's common equity retained some value through an acquisition — inverting the capital-structure order investors assumed would hold (debt senior to equity in a loss). It triggered lawsuits and a broader repricing of AT1 risk across European banks, because it demonstrated that the contractual write-down mechanism, not the normal insolvency waterfall, governs outcomes for these instruments.
Do not assume AT1 CoCo holders are senior to common equity just because bonds usually rank above stock. The write-down or conversion mechanism is contractual and can be triggered by regulators outside the normal bankruptcy priority order, and the 2023 Credit Suisse AT1 wipeout showed that shareholders can retain value while AT1 holders are zeroed out in the same event.
Related concepts
Practice in interviews
Further reading
- Avdjiev et al., CoCo Issuance and Bank Fragility, BIS Working Papers
- FINMA, Order Regarding Emergency Measures for Credit Suisse (2023)