The Additional Tier-1 bonds or AT-1 bonds garnered a lot of attention recently. This was after the RBI decided to write-off the dues of the AT-1 bonds issued by the Yes Bank as part of the restructuring package of the bank.
Yes Bank’s AT1 bonds worth ₹8,415 crores were written down in March 2020
[You may also read: What happened to the Yes Bank?- Explained]
What are AT-1 bonds?
AT-1 bonds are perpetual bonds issued by the banks to meet their capital requirement. As per the Basel-3 norms, a bank is required to maintain a minimum of 10.5 % in tier-1 capital.
[A bank’s capital is divided into Tier 1 and Tier 2 capital. Tier 1 capital is the core capital of a bank that is permanent and reliable. It is further divided into common equity which includes equity capital and disclosed reserves and additional tier-1 capital which includes AT-1 bonds. Tier 2 capital is the supplementary capital. It includes undisclosed reserves, general provisions, bonds, provisions against Non-performing Assets, etc. Therefore, banks issue AT-1 bonds to meet their Tier 1 capital requirement. ]
[You may also read: What is meant by Basel norms in banking? What is Basel 1, 2 & 3?]
Perpetual means that there is no maturity date for the bonds. These bonds have no expiration. The issuing bank has to pay a fixed rate of interest on these bonds till eternity. But, AT-1 bonds pay a higher rate of interest as compared to other bonds issued by banks and companies. Consider this- while a high rated tier-II bond of a public sector bank may have an interest rate of 7.5% per annum, its AT1 bond can carry a rate of around 9% per annum.
But, higher returns are to compensate for higher risks.
In the case of these bonds, the issuing bank has a call option. It means that the bank has the option, but not the obligation to repay the principal after 5 or 10 years. Let’s say- there is an AT-1 bond issued by SBI with a coupon rate of 10 %. It means that the bank can choose to exercise its call option and repay the principal amount after 5 years or continue to pay 10 % interest to the bondholders forever.
The interest rates on these bonds can be paid only through annual profits, and the bank can decide to skip interest payments.
Moreover, AT-1 bonds can be written off/canceled if the bank’s capital falls below certain threshold levels. The threshold is common equity tier I ratio of 5.5%. This is what happened at Yes Bank.
These bonds are listed and can be traded on a stock exchange.
What happened with Yes Bank?
The RBI asked the Yes Bank to write-off or cancel its AT-1 bonds. These bondholders had invested around Rs.10800 crores.
This decision came as a shock to investors who had parked their money in these bonds. While most of the investors (almost 90 %) in these bonds were institutional investors like mutual funds. Some were retired individuals who had invested their life-savings in these bonds.
AT-1 bonds, as explained are risky and they had been mis-sold to retail investors as a better alternative to fixed deposits. The investors are not very well-informed about the risks and they take for granted that banks will exercise their call option always.
Economyria is now on Telegram. For a simplified analysis of topics related to economy/ business/ finance, subscribe to Economyria on Telegram
However,
according to Sebi regulations,
banks can sell these bonds only
to qualified institutional buyers
(QIB) with a minimum lot size
of ₹1 crore. Is that correct?
“Only some private lenders
with good capital position are
able to issue AT1 bonds. It is
easier for public sector banks to
do it as the market knows that
the Centre will keep infusing
capital one way or the other,”
However,
according to Sebi regulations,
banks can sell these bonds only
to qualified institutional buyers
(QIB) with a minimum lot size
of ₹1 crore. Is that correct?