The country’s largest lender State Bank of India (SBI) on Wednesday said it has raised Rs 4,000 crore via additional Tier 1 bonds at a coupon rate of 7.72%, the first such issuance in the domestic market after the Securities and Exchange Board of India issued new rules.
- SBI was the first lender to raise capital through offshore AT1 bonds in 2016. Axis raises $600 mn from AT-1 bond issue on 1st Sep 2021
- Axis Bank is the second Indian lender this year to tap overseas debt markets to raise funds through AT1 bonds. HDFC Bank recently raised $1 billion.
By Now you would have understood that AT-1 Bond is News Quite frequently and so now you need to understand what is AT-1 Bond, How is it different from Other Bonds, What are the SEBI Guidelines, Risk Associated with AT-1 Bonds, Yes Bank Saga of AT-1 Bonds, AT-1 Bonds in Domestic as well as Overseas Market
What is AT-1 Bonds?
AT-1, short for Additional Tier-1 bonds, are unsecured bonds which have perpetual tenure. In other words, the bonds have no maturity date.
- It is issued by banks to shore up their core capital base to meet the Basel-III norms.
AT-1 bonds are like any other bonds issued by banks and companies, but pay a slightly higher rate of interest compared to other bonds.
- These bonds are also listed and traded on the exchanges. So, if an AT-1 bondholder needs money, he can sell it in the secondary market.
- Investors cannot return these bonds to the issuing bank and get the money. i.e there is no put option available to its holders.
- However, the issuing banks have the option to recall AT-1 bonds issued by them (termed call options that allow banks to redeem them after 5 or 10 years).
Banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels.
- AT-1 bonds are regulated by RBI, If the RBI feels that a bank needs a rescue, it can simply ask the bank to write off its outstanding AT-1 bonds without consulting its investors.
- This is what has happened to YES Bank’s AT-1 bond-holders who are said to have invested ₹10,800 crore.
- Mutual funds (MFs) are among the largest investors in perpetual debt instruments, and hold over Rs 35,000 crore of the outstanding additional tier-I bond issuances of Rs 90,000 crore.
Background:
After a string of banks turned turtle in the global financial crisis, central banks got together and decided to formulate new rules (called the Basel-III norms) that would make them maintain stronger balance sheets.
- In India, one of the key new rules brought in was that banks must maintain capital at a minimum ratio of 11.5 per cent of their risk-weighted loans.
- Of this, 9.5 per cent needs to be in Tier-1 capital and 2 per cent in Tier-2.
- Tier-1 capital refers to equity and other forms of permanent capital that stays with the bank, as deposits and loans flow in and out.
Basel-III Norms
It is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector, post 2008 financial crisis.
Under the Basel-III norms, banks were asked to maintain a certain minimum level of capital and not lend all the money they receive from deposits.
According to Basel-III norms banks' regulatory capital is divided into Tier 1 and Tier 2, while Tier 1 is subdivided into Common Equity Tier-1 (CET-1) and Additional Tier-1 (AT-1) capital.
- Common Equity Tier 1 capital includes equity instruments where returns are linked to the banks’ performance and therefore the performance of the share price. They have no maturity.
- Additional Tier-1 capital are perpetual bonds which carry a fixed coupon payable annually from past or present profits of the bank.
- They have no maturity, and their dividends can be cancelled at any time.
- Together, CET and AT-1 are called Common Equity. Under Basel III norms, minimum requirement for Common Equity Capital has been defined.
Tier 2 capital consists of unsecured subordinated debt with an original maturity of at least five years.
According to the Basel norms, if minimum Tier-1 capital falls below 6%, it allows for a write-off of these bonds.
SEBI's new AT1 bond norms
On March 10, Sebi directed mutual funds to value these perpetual bonds as a 100-year instrument.
- This essentially means MFs will have to work on the assumption that these bonds would be redeemed in 100 years.
- The regulator also asked MFs to limit ownership of the bonds at 10% of the assets of a scheme, as these could be riskier than other debt instruments.
- Sebi has possibly made this decision after the RBI allowed a write-off of Rs 8,400 crore on AT1 bonds issued by Yes Bank Ltd after it was rescued by State Bank of India.
This decision has raised a storm in the MF and banking sectors
- The Finance Ministry had asked the regulator to withdraw the changes as it could lead to disruption in the investments of mutual funds and the fund-raising plans of banks.
SEBI relaxes valuation norms for AT1 bonds
Days after the Finance Ministry asked the Securities and Exchange Board of India (SEBI) to review restrictions on mutual fund investments in additional tier-1 (AT1) bonds, Sebi has announced some relaxations in valuation norms
- On March 22, the regulator said the deemed residual maturity of Basel III AT-1 bonds will be 10 years until March 31, 2022.
- It will be increased to 20 years from April 1, 2022 to September 2022, and 30 years for the subsequent six-month period.
- From April 2023, the residual maturity will become 100 years from the date of issuance of the bond.
- However, the original position of Sebi that perpetual bonds will be treated as 100-year bonds remains; there’s no change in the 10% cap on ownership of bonds in a particular mutual fund scheme.
How would MFs have been affected by Sebi’s March 10 directive?
Typically, MFs have treated the date of the call option on AT1 bonds as maturity date.
- If these are treated as 100-year bonds, it raises the risk as they become ultra-long-term instruments.
- This could also lead to volatility in the prices of these bonds. As the risk increases, so does the yields on these bonds.
- Bond yields and bond prices move in opposite directions; higher yield will drive down the price, which in turn will lead to a decrease in the net asset value of MF schemes holding these bonds.
- There would have been panic redemptions and losses for MFs. Moreover, these bonds are not liquid and it would have been difficult for MFs to sell these to meet redemption pressure.
- With Sebi relaxing norms, there will be orderly liquidation of AT1 bond holdings.
What are the Associated risks to Investors?
AT1 bonds are quasi-equity instruments. These are meant to be like equity, but are structured as bonds.
The promise of equity is: give a company some money as equity, and it will use that money to grow. There is no obligation to pay any dividend. There is no obligation to return the money ever, and the company can use the money as it wishes
The interest can be skipped if the banks’ capital ratio falls below a certain percentage or suffers a loss.
These bonds give better returns than the rest of the bonds but have no maturity date like other bonds
These types of bonds are not suitable for regular income or capital safety goal oriented investors.
AT-1 bonds are complex hybrid instruments, ideally meant for institutions and smart investors who can decipher their terms and assess if their higher rates compensate for their higher risks.
- But in India, these bonds seem to have been sold to a fair number of retail investors as fixed deposit or NCD substitutes.
AT-1 bonds carry a face value of ₹10 lakh per bond which can huge for small investors.
There are two routes through which retail folk have acquired these bonds — initial private placement offers of AT-1 bonds by banks seeking to raise money; or secondary market buys of already-traded AT-1 bonds based on recommendations from brokers.
What happened with Yes Bank AT-1 Bonds?
When Yes Bank collapsed in early March last year and RBI wrote off the entire value (Rs8,415 crore) of the AT-1 bonds as a part of the hurriedly-put-together rescue package for the cash-strapped lender, all investors lost their money.
- Many of these investors were retired individuals who had parked a sizeable chunk of their life savings in these bonds at the behest of their relationship managers.
- Executives of Yes Bank had lured individual retail investors most of whom are above 60 years of age and were pensioners to invest in AT1 bonds issued by Yes Bank by promising high return and safe investment as FD.
- RBI can ask a bank that is dangerously on the edge to cancel its outstanding AT-1 bonds without consulting its investors, which is what happened in the case of the AT-1 bonds Yes Bank
What is Offshore AT-1 Bonds or Overseas AT-1 Bonds or Dollar Dominated AT-1 Bonds?
- When AT-1 Bonds are released for Overseas Investors or Offshore Investors who are not resident of India are called Offshore AT-1 Bonds
- India’s domestic market has turned dry and inaccessible after the SEBI tightened valuation rules for Additional Tier 1 (AT1) category securities, which used to have a large subscription from mutual funds
- With Yes Bank saga unfolded, retail investors have cautioned themselves from investing in AT-1 Bonds except SBI AT-1 bonds which is a govt backed bank but other Private lenders find it difficult to find Interest in Bonds issued.
- In that case release Overseas AT-1 bonds for Offshore Investors as done by HDFC Bank and Axis Bank recently. HDFC Bank AT-1 Bonds were subscribed Four times in overseas market which didn't much taker in domestic market.
