Why last week's fuss over AT1 bonds is bad news for bonuses

The mandatory payment of coupons on AT1 bonds (CoCo bonds), is suddenly a thing. As a reminder, the bonds, which have become a popular vehicle for raising bank capital ever since Barclays, Credit Suisse and UBS issued them 2012 were meant to be flexible when it came to coupon payments. Unlike normal bonds, banks issuing AT1s have an option whether to pay coupons or not: if they don't want to pay the coupons on AT1s, they theoretically don't have to, even if the bonds aren't in default.

Last week's upset with Deutsche suggests it's not quite as simple as this.

Following a note by research boutique Creditsights which questioned Deutsche's ability to pay coupons on its CoCos in 2017, all hell was let loose. The bonds were downgraded, their yields soared and Deutsche's share price plummeted.

The situation has since been remedied by Deutsche's insistence that it has "sufficient reserves" to pay its CoCo coupons, but neither the German bank nor any other firm which has issued CoCos will want to risk even the merest intimation of non-payment again.

This is unfortunate if you happen to work for a bank with plenty of AT1 bonds outstanding.

As Dan Davies, senior research advisor at Frontline Analysts, helpfully pointed out on Twitter at the weekend, CoCo bond coupon payments and bonuses are in direct competition when banks are in straitened times.

In Europe, both CoCo coupons and bonuses are counted in regulators' calculations of the 'Maximum Distributable Amount' (MDA) that banks can give away whilst maintaining a necessary level of capital. For this reason, Coco coupons and bonuses are "in direct competition," says Davies.

After last week, guess which of the two will win?

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