Additional Tier 1 bonds or AT1 bonds are back in the news with a clutch of banks rushing to raise funds by tapping this market. Among the lenders that have recently raised funds through AT1 Bond issues are State Bank of India (SBI), Axis Bank and HDFC Bank. The coupon rate on these bonds differs as per market conditions. Why do banks use these instruments? What are the benefits and risks for investors? Here is a primer:
What are AT1 bonds?
AT1 bonds, as these instruments are popularly known, are a type of perpetual debt instrument that banks use to augment their core equity base and thus comply with Basel III norms. These bonds were introduced by the Basel accord after the global financial crisis to protect depositors.
How are these bonds different from other debt instruments?
These bonds are perpetual in nature — they do not carry any maturity date. They offer higher returns to investors but compared with other vanilla debt products, these instruments carry a higher risk as well. If the capital ratios of the issuer fall below a certain percentage or in the event of an institutional failure, the rules allow the issuer to stop paying interest or even write down these bonds, as happened in the Yes Bank case. These bonds are subordinate to all other debt and senior only to equity.
What can investors do with AT1 bonds?
As mentioned above, AT1 bonds do not have a maturity date. Banks have a call option that permits them to redeem these bonds after a certain period.
Are they safe for investors?
Since these bonds can be written down by banks under the directions of the Reserve Bank of India (RBI) in the event of an institutional failure, they are seen as high-risk instruments. If the bank reaches the point of non-viability, AT1 bonds are the first part of debt that will be written down. AT1 bonds worth Rs 8,414 crore were written off fully during the Yes Bank reconstruction scheme in March 2020. Those AT1 investors are still locked in a court battle with the RBI and the bank seeking the return of their investments. In this backdrop, it is fair to say that AT1 bonds are high-risk instruments for investors, especially retail investors.
Why do the banks tap the AT1 bond route?
Banks periodically raise money issuing such bonds. At one point, lenders used to even pitch these to retail investors as an attractive option, often with returns higher than a traditional fixed deposit would offer. Indeed, there used to be significant retail interest in AT1 bonds till the Yes Bank episode.
The market for AT1 bonds took a hit after the Yes Bank write-off, as part of the State Bank of India-led bailout in March 2020. Investors have begun to look at these instruments with caution since then.
Which banks have taken the AT1 Bond route to raise funds recently?State Bank of India (SBI) and Axis Bank are the lenders to have most recently raised money through AT1 bonds. Axis Bank recently raised $600 million through an AT1 Bond issue, while State Bank of India announced on September 1 that it had raised Rs 4,000 crore of the Basel-compliant bonds. The country’s largest lender raised the amount at a coupon rate of 7.72 percent. In August, HDFC Bank, too, raised $1 billion by selling AT1 bonds to overseas investors.