AT-1 Bonds: Explained

Rajdeep Saini

21 Nov, 2020

The Reserve bank of India (RBI) has considered an application to write down Additional Tier-I (AT-1) bonds as a part of a package of SBI-led restructuring package for Yes Bank. So what do AT-1 bonds really mean? The AT-1 bonds are types of perpetual, unsecured bonds that banks issues to shore up their capital base to the Basel-III norms. Basel III norms are the norms that have been formulated by all the global banks mutually for the purpose of safeguarding the international banking system.

By looking at the Yes Bank crisis, the Reserve bank of India (RBI) has allowed to write down the Yes Bank’s AT1 bonds as a part of the entity’s revival plan.

What are AT-1 Bonds?

The AT-1 bonds are types of perpetual, unsecured bonds that banks issues to shore up their capital base to the Basel-III norms. Basel III norms are the norms that have been formulated by all the global banks mutually for the purpose of safeguarding the international banking system. The collapse of even a single bank in the economy creates havoc in the country. Needless to say what will a collapse of the entire banking system will mean.

There are generally 2 routes through which the bonds can be acquired:

• Private placement of AT-1 bonds by the banks looking to raise money.
  
• Secondary market buys of already traded At-1 bonds.

Whom does bank issue AT-1 bonds?

The AT-1 bonds^[1] came into being after Basel III norms have been formulated by all the global banks mutually for the purpose of safeguarding the international banking system. Due to this reason, banks all over the world are required to meet the stipulations of Basel III norms. So, international banking will remain flexible during economical or financial stress.

One of the crucial Basel III regulations are norms is that the bank required to raise the capital internally before doing so externally by means of loans and deposits. As per this basil norm, the Indian banks are obligatory to maintain a total capital ratio of an 11.5%. About 8% of this capital is known as Tier 1 capital, which fundamentally comprises of the funds raised by the banks internally, for example, reserves and equity shares. The rest 1.5% of the capital of the bank is called Tier 2 capital which includes supplementary reserves and hybrid instruments.

AT-1 bonds features

The Additional tier bonds have some specialised and unique features mentioned below:

The AT-1 bonds are non-redeemable and perpetual but have a call option

As already mentioned before, the AT1 bonds are perpetual, which means the investor cannot sell or redeem these bonds. In fact, they don’t even have a date of maturity. However, these special bonds have a call option that permits the banks to redeem them after 5 to 10 years. This means that the only bank which can decide whether to redeem that bond or not to redeem it will totally depend on the special circumstances. Any bank, having any particular clause of repayment of At-1 bond prematurely in the agreement, can also redeem these bonds even before 5-10 years.

AT-1 bonds have set a coupon rate but the bank can skip an interest payment

The Additional Tier 1 bond has a fixed interest rate called a coupon rate. The issuing bank shall pay the interest at such a rate to the holders of the AT-1 Bond. Now, the banks have the option to choose not to redeem these bonds, instead pay interest on them lifetime. However, in the case where the capital ratio of the issuing bank falls more than 8%, it can choose not to pay interest or pay only a part of interest for a specific year.

Right of the bank to write-off or write-down AT-1 Bond without investors consent

All stated the most prominent feature of an AT-1 Bond is the threat linked with the principal. In case the issuing bank’s Tier I capital falls below a certain percentage i.e. 8%, the Reserve Bank of India (RBI) can ask it to write-off its outstanding AT1 bonds devoid of even looking for the investors’ approval. That said, in the event where the issuing bank’s capital Tier 1 capital ratio falls below 6.125%, the bank can cut or write-down the principal value/ face of the bond either temporarily or permanently.

RBI Regulation on AT-1 bonds over banks

• In cases where a bank faces elevated losses leading to the erosion of the capital, the RBI has the authority to settle on whether the bank has reached to that stage wherein it is no longer feasible.
• The RBI afterward can activate a Point of Non-Viability Trigger (PONV) and presume to execute powers of the bank.
• By, doing so, the Reserve bank can do whatever is obligatory to get the bank on the track such as superseding the existing management, further forcing banks to raise supplementary capital and so on.
• Activating the PONV is followed by a write down of the AT-1 bonds, as determined by the Banking Regulation Act, 1949.
  

Conclusion

Read our article:Explaining different aspects of Covered Bonds