Finnovation - Additional Tier-1 Bonds- High Yield, High Risk

The recent Yes Bank crisis was pretty troublesome for the common folk. Many retail bankers had to go through financial trouble and metal stress. But slow recovery of the bank will dissolve their problems. However, a certain group of investors has been left strangled, i.e. owners of the bank's AT-1 bonds.

BY HARSHIT GUPTA                                                                                                     2 min read

AT-1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to strengthen up their core capital base to meet the Basel-III norms. After a series of banks turned turtle in the global financial crisis of 2008, 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.

Importance of AT-1 Bonds :-

AT-1 bonds are high risk, high yield bonds which make them different from normal bonds. Firstly, these bonds are everlasting and don't have any maturity date. Instead, they carry call options that enable banks to redeem them after five or ten years. But it is not compulsory for the banks to use this call option and they can choose to pay interest on these bonds forever.

Secondly, banks issuing AT-1 bonds can skip the payment of interest for a certain year or even decrease the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels. These thresholds are specified in their offer terms.

Thirdly, if our central bank feels that a bank is struggling and needs to be saved, it can simply ask the bank to write off its outstanding AT-1 bonds without asking its investors. Now, this is where the case of Yes Bank prevails.

With the Reserve Bank of India and the center working hard to revive Yes Bank, with SBI buying equity and the lookout for other investors, the depositors of the bank in turmoil may get a workable solution. However, the segment of investors holding the AT-1 bonds have been left in a puddle of trouble. The Yes Bank crisis led to the RBI deciding to writing off of the AT-1 bonds completely. Yes Bank's AT-1 bondholders who are supposedly invested ₹10,800 Crores have been casted aside due to the crisis with their investments to be turned to zero.

However, the bondholders are arguing that when the AT-1 bonds were issued, the commitment was: “The claims of the bondholders in bonds shall be superior to the claims of investors in equity shares and perpetual non-cumulative preference shares issued by the bank.” This means that unless the equity of the bank is also zero, the bonds can't be completely written off. Hence, a legal battle is ensured in case bonds are written off to zero.

What do we learn?

AT-1 Bonds are complex investment avenues meant for smart and experienced investors with risk assessment knowledge, but have been sold to a lot of retail investors as FD substitutes. AT-1 bonds carry a face value of ₹10 lakh per bond. These investors buy these bonds in two ways- one, initial offers by banks to purchase these bonds, two, buying already traded bonds from the secondary market.

In conclusion, lucrative bond schemes by retail banks may offer high yield, but they may have such huge risk, as in case of AT-1 bonds, which is not suitable for retail investors.