Additional tier 1
Sector Deep DivesPerpetual bank capital instruments ranking above common equity, with discretionary coupons and a contractual trigger that converts or writes them down.
Also written: AT1, contingent convertible, CoCo, CoCos
Additional tier 1 sits between common equity and tier 2 in the capital stack. The instruments are perpetual, carrying no maturity date, and they absorb losses either by converting into ordinary shares or by being written down when the issuer's CET1 ratio falls through a contractual trigger. In Europe they are usually called contingent convertibles, or CoCos.
Two features make them unlike a bond. The trigger is automatic and fires exactly when the equity is worth least, so the conversion an investor receives is the opposite of the one an ordinary convertible offers. And the coupon is discretionary: the issuer may cancel it without an event of default, and must cancel or reduce it if distributions are capped by the buffer rules.
That second feature is why these instruments trade on the capital buffer rather than on the credit. An investor in additional tier 1 is underwriting the distance between the bank's CET1 ratio and the level at which coupons stop, which is a very different exposure from the probability of the bank defaulting on senior debt.
One adjustment candidates forget. Additional tier 1 coupons are usually charged against reserves rather than through the income statement, so reported net income is not what belongs to ordinary shareholders. Deduct the coupon before computing return on tangible equity, or the return is overstated.
Worked example
Illustrative: a bank reports 1,000 of net income and pays 60 of additional tier 1 coupons out of reserves.
Earnings attributable to ordinary shareholders are 940, not 1,000. Against 8,000 of tangible equity that is a return of 11.75% rather than 12.5%.
The gap is small in any one year and it is precisely the adjustment an interviewer uses to see whether you have read a bank's accounts or only its headline.