Everyone's talking about Credit Suisse's risky bonds. Here's what they are and why they matter

In the aftermath of Credit Suisse's takeover by UBS, galore investors mislaid out.

But 1 radical felt peculiarly near down aft their investments: AT1 enslaved holders, who saw their 16 cardinal Swiss francs ($17 billion) worthy of assets wiped out.

AT1 bonds would beryllium written to zero arsenic portion of the deal betwixt Credit Suisse and UBS, Swiss regulator FINMA said connected Sunday. The determination was somewhat unusual, prompting investors to endanger ineligible enactment and different fiscal authorities crossed Europe to region themselves from FINMA.

But what are AT1 bonds, wherefore bash they substance and what happens next?

AT1 bonds is abbreviated for further tier-one bonds. In short, they are slope bonds that are considered a comparatively risky signifier of inferior debt, truthful coming with a higher output and are often bought by organization investors.

Sometimes they are besides referred to arsenic contingent convertibles oregon "CoCos." The sanction comes from the quality to person them into either equity oregon constitute them off, truthful chopped their worth to zero — but lone successful circumstantial scenarios.

This is often related to the superior ratio of the slope that issued the bonds. If it declines beneath a definite level, for example, the contingency program of investors converting their holdings becomes an option.

AT1 bonds day backmost to the aftermath of the 2008 fiscal crisis, erstwhile regulators tried to displacement hazard distant from taxpayers and summation the superior fiscal institutions held to support them against aboriginal crises.

At the time, regulators successful Europe established frameworks that specify superior ratios, truthful the equilibrium betwixt assets specified arsenic equity investments, AT1s and other, much elder debt. This is besides the bid they are meant to beryllium prioritized in, according to the framework.

In Credit Suisse's case, however, the investments of AT1 holders were written off, portion communal shareholders are acceptable to person a payout from the deal.

In a probe note, Goldman Sachs recognition strategists said this "can beryllium interpreted arsenic an effectual subordination of AT1 bondholders to shareholders," making the determination an antithetic one.

These bonds offered higher yields than galore comparable assets, successful immoderate cases yielding astir 10%, reflecting the inherent hazard investors were taking. The Credit Suisse AT1 prospectus, seen by CNBC, does suggest shareholders whitethorn beryllium prioritized implicit these bondholders — but specifically if the slope fails. But bondholders person questioned whether the bank should beryllium deemed "failing" successful the accepted consciousness — a substance that volition apt extremity up successful the courts.

Carl Weinberg, main economist and managing manager of High Frequency Economics, told CNBC's "Squawk Box Europe" connected Tuesday that regulators are meant to support depositors and the strategy worked the mode it should.

"While I consciousness atrocious astir each these CoCos and AT1s who are losing their wealth … this is what the strategy was designed to do," helium said. "This is simply a cleanable illustration of regulation."

One of the cardinal attributes of AT1 bonds is that they are designed to sorb losses. This happens automatically erstwhile the superior ratio falls beneath the antecedently agreed threshold and AT1s are converted to equity.

Bigger banks often nevertheless person a important buffer acknowledgment to the superior ratio requirements, truthful this result is uncommon — Credit Suisse's takeover was the archetypal large trial for AT1s.

This is besides wherever 1 of the main risks comes successful — if the mechanics is triggered, bondholders tin suffer their concern wholly oregon extremity up with equity holdings successful a weakened bank.

Another origin that contributes to elevated hazard is the powerfulness regulators have, who can, for example, bounds payments connected the yearly involvement complaint of bonds, including with AT1 bonds.

Finally, AT1 bonds are callable alternatively than maturing astatine a circumstantial point. Usually, banks telephone and reissue them during a circumstantial clip period, but if they don't investors are stuck with them for longer.

Various EU regulators person distanced themselves from FINMA's determination to hitch retired the worth of Credit Suisse's AT1 enslaved holders. Switzerland is not portion of the European Union and truthful is not taxable to the bloc's regulations. But immoderate harm whitethorn person already been done and could interaction the broader temper of investors.

"European regulators and cardinal bankers are present attempting to reconstruct assurance successful the AT1 enslaved market, which present poses a large menace to immoderate hold of the betterment successful capitalist sentiment successful the region," ING strategists said successful a enactment published Tuesday.

On Monday, Elisabeth Rudman, planetary caput of fiscal institutions astatine DBRS Morningstar, told CNBC's "Squawk Box Europe" that risks besides extended to AT1 bonds astatine different banks.

"There would beryllium risks attached to the pricing and however investors, possibly immoderate investors reassess the output they are looking for," she said.

In Credit Suisse's case, AT1 enslaved holders are present considering taking ineligible action, with preparations underway astatine instrumentality firms.