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Bonds indicate a debt obligation of the issuer, where the bondholders lend money for a preset maturity period. They receive regular interest payments throughout the maturity period and the principal investment amount on the maturity date. The Additional Tier I Bonds or AT1 Bonds are exceptions due to their perpetual nature.
Read on as we elaborate on the Additional Tier I Bond definition, list their salient features, and identify the associated risk factors!
Understanding Additional Tier I Bonds (AT1 Bonds)
In theory, the AT1 Bonds have no maturity period. The principal amount stays invested, and bondholders continue to earn interest till infinity, fetching them the tag of perpetual bonds. These bonds, issued by banks, are typically aimed at meeting capital adequacy requirements (CAR).
Following the financial crisis of 2007-09, BASEL III, the international regulatory framework for banks, mandated the banks to expand their core equity base and maintain a specified capital to act as a contingency fund. Note that the minimum capital ratio should be 11.5% of the bank’s risk-weighted loans, and 9.5% of this must be formed with Tier 1 capital. Banks issue additional Tier I bonds as per the CAR in accordance with RBI’s instructions to comply with regulatory directives.
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Key Features of Additional Tier I Bonds
The absence of any specific maturity period defines these perpetual debt instruments. Below are some more pivotal characteristics to explain the bonds further.
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Interest Rate
These Additional Tier I Bonds are known to generate interest at higher rates than other types of bonds.
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Liquidity
The AT1 Bonds do not have any put option, restricting the bondholders from selling them back to the banks. That said, they are listed on stock exchanges, hence, investors can enjoy liquidity to some extent.
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Call Option
The concept of no particular maturity period stands, but the issuing bank can exercise the call option before the maturity date. The call option becomes available after 5 or 10 years from the date of the bond issuance.
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Contingent Convertibility
AT1 Bonds are often referred to as Contingent Convertible Bonds because they can be converted into equity at any time if a financial crisis arises. It is a way to reduce the bank’s debt obligation while keeping the capital intact.
Risk Factors
In the investment market, high risk often shadows high interest rates. Exceptions exist, but for Additional Tier I Bonds, several risk factors remain!
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Risk of Interest Payment
The risk of interest payment default can undermine the benefit of high interest rates. Banks can decide to shelve the interest payment in case of a loss or any other crisis.
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Subordinate Debt Treatment
AT1 Bonds are subordinate bonds in nature, ranking lower than other debt obligations when prioritising payment order in case the bank fails.
Note: Bondholders are prioritised over shareholders when a bank collapses. However, the Credit Suisse incident, which became an international headline, showed shareholders receiving hefty amounts, with the bondholders basically getting nothing.
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Risk of Write-Off
Additional Tier I Bonds can be completely written off, leaving the bondholders at a complete loss. A recent example is the Yes Bank write-off of 2020. RBI wrote off Yes Bank’s AT1 Bonds worth INR 8,415 crore.
Wrapping Up!
The high interest rates are the prime attraction of Additional Tier I Bonds. The possibility of interest payment default and write-off levy considerable risk on the investment. National and international instances added to the concern, but the Indian banks are making efforts to further explore the AT1 Bond market and bring lucrative opportunities for investors.
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FAQs About What are Additional Tier I Bonds?
1. Who can invest in Additional Tier I Bonds?
While these bonds are open to the public, they are best suited for high-net-worth individuals and institutional investors due to their unsecured, high-risk character.
2. What is the interest rate of AT1 Bonds?
The AT1 Bonds offer higher rates of interest than other bonds. It differs from bank to bank. For instance, SBI has issued AT1 Bonds with a rate of 8.1%, whereas the National Bank offered 8.59%.
3. Are AT1 Bond investments safe?
AT1 Bonds carry high risk. There are risks of interest payment default, untimely calls, write-offs, and so on. Investors must have a high-risk appetite.
