What Are AT1 Bonds? - TheMoneyFarm

AT1 bonds, as they’re known, are a sort of perpetual debt instrument that banks utilize to supplement their basic equity base and meet Basel III requirements. Following the global financial crisis, the Basel agreement created these bonds to protect depositors.

These bonds are eternal in nature, meaning they have no expiration date. They provide investors with larger profits, but they also involve a higher risk as compared to traditional debt securities. The laws allow the issuer to stop paying interest or even write down these bonds if the issuer’s capital ratios fall below a particular percentage or if the firm fails, as happened in the Yes Bank case. These bonds are senior solely to equity and subordinate to all other debt.

What exactly are AT1 bonds in India?

AT1 bonds, often known as perpetual bonds, have no set maturity date but can be called at any time. If the issuer of such bonds can acquire money at a lower rate, especially while interest rates are falling, the issuer may call or redeem the bonds.
They are similar to other bank and company bonds in that they pay a little greater rate of interest than other bonds.
These bonds are issued by banks to supplement their core capital base in order to meet Basel-III requirements.
These bonds are also listed on exchanges and traded. As a result, if an AT-1 bondholder requires cash, he can sell it on the secondary market.
Investors will not be able to get their money back if they return these bonds to the issuing bank. Holders of the stock do not have the opportunity to sell it.
Banks that issue AT-1 bonds have the option of deferring interest payments for a year or even lowering the face value of the bonds.
The Reserve Bank of India regulates AT-1 bonds (RBI). If the RBI believes a bank requires assistance, it can simply instruct the bank to write off its outstanding AT-1 bonds without engaging the bank’s stockholders.

Basel III Norms

It is an international regulatory agreement that implemented a package of changes aimed at improving banking sector regulation, supervision, and risk management following the 2008 financial crisis.
Banks were required to retain a specific minimum level of capital and not lend all of the money they received from deposits under the Basel-III rules.
Bank regulatory capital is separated into Tier 1 and Tier 2 according to Basel-III standards, with Tier 1 further broken into Common Equity Tier-1 (CET-1) and Additional Tier-1 (AT-1) capital.
Common Equity Tier 1 capital consists of equity instruments whose returns are tied to the success of the banks and, as a result, to the performance of the stock price. They haven’t reached adulthood.
CET and AT-1 are referred to as Common Equity when used together. A minimum need for Common Equity Capital has been established under Basel III regulations.
Tier 2 capital is made up of unsecured subordinated debt with a minimum five-year maturity.
If the minimum Tier-1 capital falls below 6%, the bonds can be written off, according to Basel standards.

AT1 bonds were issued by WHO?

The State Bank of India (SBI) has obtained Rs 3,974 crore in additional capital through tier 1 notes (AT1 bonds). The AT1 bonds’ coupon was set at 7.55 percent, which is 17 basis points lower than the previous offering in September 2021.

The reaction to SBI’s offering was positive, according to bond dealers. The issue received bids in excess of Rs 6,000 crore, despite the estimated size of Rs 4,000 crore. It chose a Rs 3,974 crore bond with a 7.55 percent coupon.

What are Yes Bank’s AT1 bonds?

This ran counter to popular perceptions of what happens in a company’s worst-case scenarioinsolvency or bankruptcy. In the waterfall system of India’s insolvency proceedings, bondholders are recognized as creditors, and their claims are judged more urgent. When a corporation goes bankrupt, equity shareholders come last and can expect to be wiped out. Yes Bank, on the other hand, was not liquidated; instead, it was reformed. Unlike AT-1 bondholders, equity investors were diluted but not wiped out. Despite the fact that AT-1 bonds are a unique type of bond, they were marketed to investors without proper risk disclosures. As a result, investors who were marketed the bonds as a substitute for fixed deposits were informed that their funds had vanished.

The implosion’s debris is still littering India’s legal and financial regulatory environment nearly two years later. The decision is being challenged in court by bondholders and mutual funds who have invested in the company.

What is the difference between AT1 and AT2 bonds?

Revaluation reserves, hybrid capital instruments and subordinated term debt, general loan-loss reserves, and concealed reserves are also part of Tier 2 capital.
Tier 2 capital is seen as less trustworthy than Tier 1 capital since it is more difficult to measure precisely and liquidate.

What is Upsc masala?

Masala Bonds are bonds that are denominated in rupees. It is a debt instrument issued in overseas markets by an Indian entity to raise funds in Indian rupees rather than dollars or local currency.

What is the capital of CET1?

CET1 (Common Equity Tier 1) is a Tier 1 capital component made up primarily of common stock held by a bank or other financial institution. It’s a capital measure that was implemented in 2014 as a preventative step to preserve the economy from a financial disaster.

AT1 bonds do not have which of the following characteristics?

So, despite having a face value and a fixed coupon rate, why are AT1 bonds not like fixed deposits or ordinary bonds? Because of the five characteristics listed below.

Option not to call

When you buy FDs or NCDs, you know exactly when your money will mature. AT1 bonds do not have a set maturity date because they are perpetual bonds that are designed to stay with the bank as long as it needs money.

Because they all have a call option by the issuer, AT1 bonds are frequently (mis) marketed as limited-period bonds. If the issuing bank has no need for the extra money, AT1 bonds allow them to be freely redeemed at the end of 5 or 10 years. Because the call option is optional, the bank determines the call option date, when it will either pay back your principle or just continue paying interest indefinitely.

Intermediaries and buyers of these bonds in India, on the other hand, frequently assume that the issuing bank will exercise its call option at the end of 5 or 10 years. This expectation has long been reflected in the bond’s pricing and rates.

While both banks and policymakers have been reluctant about bypassing the call option, it is very likely that a bank will exercise this right sooner or later. Andhra Bank had planned to skip the call option on its AT1 bond after five years in December, but after market outcry, it changed its mind.

Regardless of market opinions, AT1 bond investors should be prepared to approach these bonds as perpetual products because this is part of their contract provisions. As a result, they are unsuitable for goals with a set deadline.

Early recall on events

While the ability to call an AT1 bond after 5 or 10 years allows issuing banks to treat them as everlasting, they can also return them sooner without informing you. AT1 bonds have a provision in the terms that allows the bank to repay them early if a tax or regulatory event arises that was not anticipated at the time of the issue.

This can result in your AT1 bonds expiring sooner than expected, putting you at risk of reinvestment (the risk of finding similar-return instruments to invest your proceeds in). In March 2018, four public sector banks, IDBI Bank, Oriental Bank, Dena Bank, and Bank of Maharashtra, who had issued high-yielding AT1 bonds, chose to recall them under the RBI’s Prompt Corrective Action framework, citing the “regulatory event” provision.

People who had purchased these bonds at a premium on the secondary markets were similarly taken off guard by the early recall, as redemptions by call are only at face value.

Skipping interest

AT1 bonds have a significant feature that distinguishes them from fixed deposits or NCDs: they can omit interest payments without creditors being able to sue them for default.

When a bank’s Common Equity Tier 1 ratio (CET 1 ratio) falls below 8%, the bank has the option to partially or completely forego interest payments. The contract clauses also allow banks to defer coupon payments if they lose money and don’t have enough reserves to cover the loss.

Because AT1s are primarily designed to help banks shore up their equity capital, they include provisions that allow a bank to forego interest payments if its capital falls below the regulatory requirement when the interest is due. When a bank’s Common Equity Tier 1 ratio (CET 1 ratio) falls below 8%, the bank has the option to partially or completely forego interest payments. The RBI has set various CET1 (below 8%) threshold levels below which the bank can lower its interest distribution by 60%, 40%, 20%, or even altogether for the year. The contract clauses also allow banks to defer coupon payments if they lose money and don’t have enough reserves to cover the loss. As a result, holders of AT1 bonds must scour their banks’ quarterly financial filings for CRAR, CET1, and profitability ratios like hawks to ensure the certainty of their payouts.

Because no banks have used the opportunity to skip coupons, both intermediaries who sell AT1 bonds and investors who buy them frequently take these conditions for granted. The government has rushed funds into several PSU banks to ensure that interest payments are met. However, this cannot be used as an excuse for investors in these bonds to be oblivious of the dangers they are taking.

Principal write-downs

If the bank’s financials become shaky, not only are your interest distributions from an AT1 bond at risk, but so is your principle value. The ‘principal loss absorption’ feature of all AT1 bonds is a significant contract term. Simply put, if the CET ratio goes below 6.125 percent, the bank that issued the bond can write down the bond’s face value (your principal) either temporarily or permanently.

Point-of-non-viability

In addition to all of the aforementioned, all AT1 bonds have a clinching clause that might catch investors off guard. This is the RBI’s full authority to order a bank to write down the entire value of its outstanding AT1 bonds if it believes the bank has passed the Point of Non Viability (PONV) or requires a public capital infusion to stay afloat.

The holders of Yes Bank AT1 bonds have been caught off guard by the PONV clause. Though the bank’s most recent financials did not show that it had broken any of the other CET1 conditions, the bank’s financial position deteriorated so dramatically in the six months between September 2019 and March 2020 that RBI was compelled to construct a bailout package for it.

What happened to the AT1 bonds issued by Yes Bank?

The case concerns YES Bank’s restructuring plan, which was revealed in March 2020 and allowed the bank to retire its Rs 8,415 crore AT1 bonds. The write-down was based on Basel III guidelines, which permitted banks to liquidate these assets in the event of a crisis.

Are bonds issued by Yes Bank safe?

The SAT order explained its reasoning for the temporary stay, saying, “We also discover that the relationship manager is not scheduled. The Relationship Managers, who were part of the inquiry but not the noticees in these actions, can best clarify the question of whether the buyers were advised of the risk element with relation to the AT-1 Bonds. Members of the Private Wealth Management Team, on the other hand, have been issued noticees and have been fined by the contested order.”

It went on to say, “We also discovered that the risk factor was already present on the website and that everyone was aware of it. In light of the foregoing, a prima facie cause for the issuance of an interim order exists.”

Yes Bank executives are accused of selling AT-1 bonds to investors under the pretext of Super FDs, which promise more returns and safety than a traditional bank FD. According to the framework of the YES Bank reconstruction scheme, YES Bank, which was bailed out in March last year by a bank consortium led by State Bank of India (SBI), wrote down Rs 8,415 crore of AT-1 bonds. AT-1 Bonds are a type of perpetual bond used by banks to raise capital.

Following this, investors filed lawsuits arguing that the bank sold them these bonds based on false guarantees, and that the bank should compensate them. The matter is still being heard in the Bombay High Court. YES Bank and the RBI have both stated that the AT-1 bond write-off follows Basel III guidelines. Institutional investors, such as Indiabulls and 63 Moons Technologies, have also moved the courts.

The Securities and Exchange Board of India (SEBI) has levied penalties under Section 15-I of the Sebi Act. According to the decision issued by adjudicating officer Soma Majumdar, if the fines are not paid within 45 days, Sebi would begin the collection procedure.

In October 2020, Sebi issued show cause notices to all parties following an inquiry. YES Bank staff did not follow proper processes while offering these bonds to investors, according to the Sebi inquiry, including not sharing the term sheets with individual investors.

“The down-sell of AT1 bonds was also not arranged between purchasers and sellers individually, according to the study. “The same as facilitated by YES Bank for approximately 1300 individual investors, the majority of whom were YES Bank customers,” the Sebi probe found.

YBL also promoted AT1 Bonds as Super FD and ‘as safe as FD,’ according to SEBI. According to the study, no confirmation was obtained from the investors about their awareness of the bond’s features and hazards.

The investigation also discovered that the MD & CEO of YBL’s pressure to down-sell AT-1 bonds prompted the private wealth management team to sell the bonds to individual investors recklessly.

SEBI discovered the following after reviewing the responses: “AT-1 Bonds were sold to YBL customers without adequate safeguards to protect their interests and without sufficient due diligence,” according to the Sebi order, which also stated that the allegations that YES Bank sold AT-1 bonds to investors posing as Super FDs have been proven.