AT1 bonds are a type of debt that is issued by banks to raise funds from investors. These loans typically have a longer term than fixed deposit and offer higher interest rates, which is why they are attractive to investors. However, they are also considered a high risk investment and can lose value if a bank goes under.
A number of lenders have recently used the AT1 bond route to raise money, including State Bank of India (SBI), Axis Bank and HDFC Bank. These deals have been aimed at raising funds to meet Basel-compliant requirements, and offer a high yield with low volatility.
The AT1 bonds are a key component of a bank’s capital ratios and are senior to other debt. In a writedown scenario, these loans are usually the first to be written down if the issuer’s Capital Equity Tier 1 (CET1) falls below certain threshold levels. The RBI has the power to ask the issuing bank to cancel the bonds if it deems this necessary. This has happened in Yes Bank, where Rs8,415 crores worth of AT1 bonds were wiped out entirely by the central bank in March 2020.
At1 Bonds Are High Risk
AT1 bonds are considered to be high risk due to the fact that they are unsecured and can be written off by the issuer in case of institutional failure. In a writedown, the bank may not be able to pay back the interest on the bonds, and it can even reduce their face value. This can cause huge losses to the investors in these bonds, which is why it is important to choose wisely.
Selecting an AT1 Bond
When you are buying an AT1 bond, it is crucial to consider several factors such as the size of the balance sheet, credit rating and corporate governance standards. These will help you to determine the risk level of a particular bank and whether you should invest in it.
For example, if you are looking for long-term investments, you should opt for banks that have a stable business model and are likely to stay profitable in the future. You should also make sure that the bank is well regulated.
Hence, it is important to select an AT1 bond from a reputable bank. You can do this by comparing the bank’s bond yield with other similar bonds in the market.
Another factor to consider is the call date profile of AT1 bonds. If the bond has a similar call date profile as government securities, it will have a lower yield than the G-Secs. In this case, it is advisable to wait for the spreads to narrow before you purchase these bonds.
The YES Bank mess should not deter you from investing in AT1 bonds of higher-quality banks, but it is essential to check the bond’s compensation level. You should also compare the AT1 bond’s coupon rate with that of government securities (G-Secs) to assess the quality of the debt instrument.