AT1 Bonds

AT1 bonds (Additional Tier 1 bonds) are a type of perpetual bond issued by banks to raise regulatory capital under the Basel III framework. They qualify as Additional Tier 1 capital, which is a layer of capital above the core Tier 1 equity. AT1 bonds offer higher interest rates than regular bonds but carry significant risk because they can be written down or converted to equity if the issuing bank’s capital falls below a specified threshold.

What Are AT1 Bonds?

Under the Basel III capital framework, banks must maintain certain capital buffers. AT1 capital is a hybrid instrument: it is debt-like (pays a fixed coupon) but equity-like in that it can absorb losses when the bank faces distress.

AT1 bonds are perpetual (no fixed maturity), and the bank has the option to call them typically after 5 to 10 years. If the bank does not exercise the call, the bonds continue to pay interest.

Key Features

– **Perpetual**: no fixed maturity date
– **Call option**: issuer can redeem after a specified date (usually 5 to 10 years)
– **Higher coupon**: 8.5% to 10%+ for well-rated Indian banks
– **Write-down mechanism**: principal can be written down (partially or fully) if the bank’s Common Equity Tier 1 (CET1) ratio falls below 5.5% (or the RBI-specified trigger)
– **Coupon suspension**: the issuer can skip coupon payments if profit is insufficient, without it being classified as default

Why AT1 Bonds Are Risky

The Yes Bank crisis in 2020 demonstrated the real risk. When Yes Bank was placed under a moratorium, its entire Rs 8,415 crore of AT1 bonds was written down to zero under RBI’s restructuring scheme. Bondholders who thought they held a safe high-yield investment lost all their principal.

Who Invests in AT1 Bonds?

Primarily:
– Institutional investors and banks
– Debt mutual funds (specifically medium-duration and hybrid funds in some cases)
– High-net-worth individuals seeking high yield with awareness of the risk

SEBI subsequently tightened rules requiring mutual funds to reduce AT1 bond holdings and restricting retail investor access.

AT1 Bonds vs Regular Bank Bonds

| Feature | AT1 Bond | Regular Bank Bond |
|———|———-|——————|
| Seniority | Junior (can be written off) | Senior (safer) |
| Coupon | Higher (9%+) | Lower (7-8%) |
| Maturity | Perpetual | Fixed (3-10 years) |
| Risk | High | Moderate |

Practical Example

A well-rated public sector bank issues AT1 bonds at 9.5% with a 10-year call option. An institutional investor buys Rs 1 crore. They receive Rs 9.5 lakh per year in interest. After 10 years, the bank calls the bond and repays Rs 1 crore. In this scenario, the investment works well. However, if the bank’s financials deteriorate and CET1 falls below the trigger, the Rs 1 crore can be partially or fully wiped out.

Key Takeaways

– AT1 bonds are perpetual, high-coupon bonds issued by banks as regulatory capital under Basel III
– They can be written down to zero if the bank’s CET1 capital ratio falls below the trigger level
– Yes Bank’s 2020 write-down is a key cautionary example for AT1 bond investors
– SEBI has restricted retail mutual fund exposure to AT1 bonds after the Yes Bank incident
– Suitable only for sophisticated investors who fully understand the write-down and perpetuity risk