Recent liquidations of Banco Popular Espanol, Banca Popolare di Vicenza and Veneto Banca have put Tier 1 and Tier 2 securities under the spot light. In the case of the Spanish bank, holders of both Tier 1 and Tier 2 securities got cleaned out. For each type of security, the non-viability clause was triggered, the securities were converted to ordinary shares and all shareholders at that point got to share in €1. In other words, they got nothing. A similar process occurred with the two Italian banks
So what is the difference between Tier 1 and Tier 2 securities? One way to think about Tier 1 securities is they are essentially a form of equity (shares/units) in their nature but they are shaped in a way to look as if they are debt instruments. That is, they have a face value, usually $100 and distributions are paid according to a formula, such as BBSW + 3.00%. This is all very much similar to the way debt securities are structured.
Tier 2 securities are essentially debt securities but they share a feature with convertible notes in the sense there is a conversion mechanism which redeems the bond and then applies the proceeds to buy shares from the issuer according to some pre-defined formula. The difference is a convertible note is convertible at the option of the holder. Tier 2 securities will have a clause which causes conversion, not at the option of the holder but at the option of the issuer and/or regulator when the issuer is deemed to be non-viable. Hence it is called a non-viability clause. It is this trigger which will be activated when the issuer of a Tier 2 security is in financial difficulty.