AT-1 bonds – IFSCCodeof.in

Role reversal: India Inc ‘lending’ to banks via AT-1 bonds

November 25, 2021 root Banking & Finance

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A role reversal seems to be happening in the Indian financial markets, with India Inc lending to banks instead of borrowing from them.

High returns on investments in Additional Tier-I (AT) bonds issued by public sector banks is proving to be attractive for large corporates even as bank credit to them has declined.

This development comes amid mutual funds avoiding AT-1 bonds (Perpetual Debt Instruments) due to SEBI restrictions.

Given that corporates have substantially deleveraged over the last few years and are sitting on the fence when it comes to fresh capital expenditure, they are channelising their surplus funds parked with banks and mutual funds into AT-1 bonds, according to a fund manager with an MF.

Bank credit to large industries contracted by 1 per cent in September 2021 against a contraction of 0.2 per cent a year ago, per latest RBI data.

Opportunistic investment

The investment by corporates in PSBs’ AT-1 bonds is opportunistic. Banks are offering relatively higher interest rates on these bonds to attract investors after SEBI’s March 2021 circular on “investment in instruments having special features and valuation of perpetual bonds” discouraged MFs from investing in them.

Union Bank of India recently raised ₹2,000 crore via AT-1 bonds at a coupon rate of 8.70 per cent. The PSB had earlier mopped up resources via AT-1 bonds twice — ₹1,000 crore (coupon: 8.64 per cent) in early January 2021 and ₹205 crore (8.73 per cent) late the same month.

Though AT-1 bonds are perpetual in nature, banks usually exercise the call option at the end of five years from the date of issuance. So, a corporate can earn higher returns by investing in these bonds than by parking in a five-year term deposit which fetches about 5.50 per cent.

PSBs are raising resources through AT-1 bonds as they have call options due in the current fiscal and the next on the bonds they had issued earlier. Bank of Baroda, Canara Bank and Punjab National Bank are among the PSBs believed to be considering raising resources via AT-1 route.

MFs shrink away

Among the reasons for MFs to keep away from these bonds is that their maturity is treated as 100 years from their date of issuance for the purpose of valuation as against the current practice of valuing them based on the time left for the next call option date.

So, MFs fear mark-to-market losses due to this change in the valuation norm, for if interest rates rise, the price of longer tenure bonds will depreciate much more than the short-to-medium term instruments.

By ICRA’s estimates based on industry data, MFs held 30 per cent of the outstanding Tier-I bonds and 14 per cent of the outstanding Tier-II bonds as on February 2021.

The credit rating agency assessed that the holding of Basel III compliant AT-I and Tier-II instruments is estimated at 8 per cent of the assets under management of MF schemes holding these instruments, thereby limiting the headroom for incremental investments.

ICRA, in its outlook for the banking sector for FY22, had estimated the Tier-I capital requirements for PSBs at ₹43,000 crore, of which ₹23,000 crore is on account of call options falling due on AT-I bonds, while the balance is estimated as the equity.

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CARE Ratings revises ratings of AT I Bonds of 4 public banks

November 24, 2021 root Banking & Finance

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CARE Ratings has revised the ratings of AT I Bonds of four public sector banks including Canara Bank, Indian Bank, Punjab National Bank and Union Bank of India. It considered the strengthening in the overall credit profile of the banks including improvement in capital cushions over the minimum regulatory requirement, improvement in both profitabilities as well as the distributable reserves position.

While rating instruments are issued by public sector banks (PSB), CARE Ratings assigns high weightage to support from the Government of India (GoI) due to its majority shareholding and the systemic importance of these banks in the Indian financial system.

Considering the significant size and financial franchise of the banks, a default by a PSB would have material economic consequences for the government as well as regulators, hence, the importance of PSBs for GOI and the economy as a whole cannot be undermined. Additional Tier I (AT I) Bonds are perpetual debt instruments that banks are allowed to raise under the Basel III capital framework and form a part of Tier I capital for banks. These instruments have several unique features, which make them very different from other types of debt instruments and provide them equity.

The issuing bank has full discretion over coupon payments at all times on these instruments. Therefore, if a bank does not have sufficient distributable reserves to service the coupon on AT I Bonds, it may not pay the coupon. These bonds also have loss-absorption features through conversion/writedown/ write-off on breach of pre-specified trigger on capitalisation requirement or at the point of non-viability (PONV) which may be decided by the Reserve Bank of India (RBI).

As per CARE Ratings’ criteria for rating of hybrid instruments issued by banks, CARE Ratings has been notching down the AT I Bonds issued by the banks by one to several notches below the Tier II Bonds rating depending on the expected adequacy of eligible reserves, cushion over minimum regulatory capital and other credit risk assessment parameters of the individual bank to factor in the additional risk in these instruments on account of several unique features.

In the last few years, PSBs have received significant government as well as regulatory support. GOI has initiated consolidation of the sector by amalgamation of relatively weaker and smaller banks into anchor banks which have gained significant scale increasing their economic and systemic importance and has further recapitalised these banks.

“With the strengthening of the resolution of NPAs under the Insolvency and Bankruptcy Code (IBC) process, the banks have seen recoveries in some of the large NPAs. The banks also have made higher provisioning on bad assets and additional provisioning in anticipation of expected losses due to Covid-19 which has increased the provision coverage ratio (PCR) and provided strength to the balance sheets of these banks,” the rating agency said.

“Further, instances of GOI and regulatory support by way of broadening of the definition of distributable reserves to include more categories of reserves as distributable reserves and allowing accumulated losses to be set-off against the share premium account which has increased the ability of PSBs to service the coupons of AT I Bonds, reiterate that the stance to extend support even to hybrid instruments. PSBs are expected to receive capital support well in advance so that the coupon payment trigger is not breached in future,” it added.

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PSBs line up local AT-1 bonds issues, but private-sector lenders stay away, BFSI News, ET BFSI

November 20, 2021 root Banking & Finance

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Public sector banks have started issuing AT-1 bonds in the domestic market more than a year after wriding down of such bonds of Yes Bank spooked the market

However, private sector banks are still keeping away and raising money via the instrument overseas, where interest rates are low.

At present, nearly three-four state-owned including SBI, Union Bank, Canara Bank and Bank of Baroda are looking to raise funds through AT-1 bonds.

In March this year, prodded by the Finance Ministry, the Securities and Exchange Board of India (Sebi) had relaxations in valuation norms. However, the main issues that AT1 bonds will continue to be treated as 100-year bonds stayed. The deemed residual maturity of Basel-III AT-1 bonds would be 10-year until March 31, 2022. Sebi said from April to September 2022, it would be valid at 20 years, and from October 2022 to March 2023, it would have a life span of 30 years. From April 2023, the residual maturity will be 100 years from the date of issuance of the bond.

In September SBI Rs 4,000 crore via additional Tier 1 bonds at a coupon rate of 7.72%, the first such issuance in the domestic market after Sebi issued new rules.

The plan

SBI is weighing options to raise money either through local additional tier-1 securities for the third time in this financial year or rupee-denominated ‘masala’ bonds for overseas investors. Bank of Baroda has approved the issuance of AT1 and AT11 bonds worth Rs3000 crore. Capital Raising Committee of our Bank has today approved the issuance of Basel III Compliant Additional Tier 1 (AT1) / Tier II Bonds for an aggregate total issue size of Rs3000cr in single or multiple tranches,” the bank said earlier this month.

What are AT1 bonds?

These are unsecured bonds which have perpetual tenure — or no maturity date. They have a call option, which can be used by the banks to buy these bonds back from investors. AT1 bonds are subordinate to all other debt and only senior to common equity. Mutual funds are among the largest investors in perpetual debt instruments, and hold over Rs 35,000 crore of the outstanding additional tier-I bond issuances of Rs 90,000 crore.

The mutual fund position

Mutual funds, which once used to buy heavily in AT1 bonds, are lukewarm about this asset class after the banking regulator last year ordered that these instruments be written off in Yes Bank’s state-sponsored bailout. Also, on March 10, Sebi had ordered mutual funds to cap ownership of bonds with special features at 10% of the assets of a scheme and value them as 100-year instruments from next month, potentially triggering a redemption wave. Later, the capital markets regulator eased valuation rules but with some riders after the finance ministry asked it to withdraw the directive to mutual funds.

The muted response by MFs had prompted the lenders to tap the overseas market.

Perpetual bond sales by banks have nearly halved to Rs 18,772 crore in FY21 from Rs 34,860 crore three years earlier.

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HDFC Bank plans to raise funds via AT-1 bonds from overseas market, BFSI News, ET BFSI

August 16, 2021 root Banking & Finance

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NEW DELHI: HDFC Bank on Monday said the bank plans to raise capital by additional tier- I (AT1) bonds in the overseas market to fund its business growth.

The bank is expected to raise up to USD 1 billion from these dollar denominated bonds.

“We hereby inform you that the bank had approved the issuing of debt instruments in the form of the notes, subject to market conditions,” HDFC Bank said in a regulatory filing.

An offering memorandum (OM) has been prepared and shall be made available to the prospective investors in relation to the contemplated issue of notes, it said.

The notes will not be offered or sold in India under the applicable laws, including the Companies Act, 2013, as amended from time to time, it added.

Earlier in April, the bank had informed that it is planning to raise up Rs 50,000 crore during the next 12 months through issuing bonds.

“The bank proposes to raise funds by issuing perpetual debt instruments (part of additional tier-I capital), tier-II capital bonds and long-term bonds (financing of infrastructure and affordable housing) up to a total amount of Rs 50,000 crore over the period of the next 12 months through the private placement mode,” HDFC Bank had said.

Perpetual bonds carry no maturity date, so they may be treated as equity, not as debt.

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Perpetual bonds – where do we go from here?

April 26, 2021 root Banking & Finance

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It has been over a month since SEBI announced guidelines for perpetual bonds and almost a month since the valuation of such bonds under the new methodology has been implemented. Before we get into implications of such valuation, lets quickly understand what these bonds are, and how did they actually impact market sentiment.

AT-1 (additional tier 1) bonds are issued predominantly by banks to raise additional Tier 1 capital without any maturity date (perpetual), but they have a call option. Banks issue AT-1 bonds to meet their capital adequacy requirement. Higher capital adequacy norms came into force with the implementation of Basel III guidelines.

These guidelines were formed after the 2008 financial crisis with the collapse of a few banks and financial institutions. Similarly, Basel III Tier 2 bonds issued by banks are expected to provide to their depositors and senior creditors an additional layer of protection.

According to the Basel III guidelines issued by the RBI, Basel III-compliant Tier 2 bonds normally come with a finite maturity.

The regulation

On March 10,SEBI put certain restrictions on investment in these bonds by Mutual Funds – no mutual fund under all its schemes shall own more than 10 per cent of such instruments issued by a single issuer; mutual fund scheme shall not invest (a) more than 10 per cent of its NAV of the debt portfolio of the scheme in such instruments and (b) more than 5 per cent of its NAV of the debt portfolio of the scheme in such instruments issued by a single issuer; and the investments of mutual fund schemes in such instruments in excess of the limits specified may be grandfathered, and such mutual fund schemes shall not make any fresh investment in such instruments until the investment comes below the specified limits. Given that mutual fund ownership of such Tier 1 bonds was around one-third of the total outstanding, it did create some anxiety across the perpetual bond segment.

Yields on such bonds shot up by ~1 per cent. The assumption here was MFs will panic exit such bonds and, hence, bids started inching up.

The volatility in perpetual bond space we saw was largely due to the uncertainty around the impact of valuation methodology. It is important to keep in mind that this in no way was a credit event, but a valuation method change for mutual funds. Since then, the yields have only softened (eased by 50-60 bps) from peak levels as carry chasers stepped in to buy such bonds. Also, we did not see mutual funds undertake panic sales, as the regulator has allowed grandfathering of such exposures.

What’s next?

Markets have now reconciled to business as usual with regard to perpetual bonds. It is important to note that the regulator has not barred MFs from investing in such bonds. Hence, the option remains with MF managers whether or not they would want to own such bonds. All perpetual bonds cannot be categorised as one. Like every debt instrument, perpetual bonds should be evaluated based on the banks fundamentals.

The primary focus remains to evaluate such bonds basis the underlying credit metrics, capital adequacy ratios and systemic importance to the Indian economy. As an investor, one needs to follow the same process in case he/she has exposure to AT1 bonds directly or via mutual funds. The current interest rate scenario may mean adequate liquidity and range-bound interest rates.

In such a scenario, carry yield in fixed income assumes a lot of significance. Such bonds do offer a spread over plain vanilla bonds. The acid test, however, would be to see how the appetite is if banks issue fresh bonds. Also, with valuations now being delinked from call option date, will banks want to continue to hold on to the existing bonds rather than exercising a call option on such bonds?

Markets will get more clarity over next few months as some tier 1 bonds approach their call date. However, market activity in such bonds so far is suggestive of call option being exercised, though it will have to be a wait and watch.

To sum up, AT1 bond offers credit comfort (based on underlying) and reasonable accruals for the investor. In case of MFs, it would best left to the discretion of the portfolio manager to hold the AT1 bonds till call/maturity as per the investment contours of respective schemes. Investors should be aware of the nature of the underlying investment rather than any action based on external noises. After all panic leads to pain, no one really stands to gain.

(The writer is CIO – Debt & Head – Products, Kotak Mahindra Asset Management Company. Views expressed are personal and do not reflect the views of Kotak Mahindra Asset Management Company Limited)

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Useful tips to avoid falling prey to bank mis-selling

April 24, 2021 root Personal Finance

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In investing, as in life, it is useful to learn from other people’s mistakes. Some retail investors lost big money in Yes Bank’s Additional Tier 1 (AT-1) bonds last year, after Reserve Bank of India decided to write them off as part of a bailout package. But how did safety-seeking depositors in Yes Bank end up owning these risky bonds where the principal could get written off? SEBI’s order in this case offers some learnings on how you can avoid falling victim to mis-selling.

Get it in writing

In their complaints, the 11 investors said that it was the attractive pitches from their bank’s wealth managers that convinced them to buy the bonds. Some were told that AT-1 bonds were ‘super FDs’. Others swallowed the claim that they were ‘safer than Yes Bank FDs and equity shares.’ Some investors even thought they were merely renewing their FDs with the bank at a higher rate.

Given that none of the above statements were true, it is unlikely that the bank’s relationship managers made these claims in writing to the investors. They were simply taken in by verbal sales pitches.

While selling AT-1 bonds, bank managers were mandatorily required to share two documents with investors – an information memorandum and a term sheet. Asked by SEBI why they didn’t do so in this case, they either claimed that they did, or argued that investors ought to have checked these documents for themselves from the BSE website where they are posted.

Most of us are in the habit of investing in financial products based merely on an application form. The Yes Bank case shows just how injurious this can be to our wealth. Today, no financial product can be sold to you without a formal offer document, information memorandum, term sheet or prospectus. If you’re given only an application form, don’t hesitate to ask for and get hold of these additional documents.

The depositor isn’t king

SEBI’s findings show that of the 1,346 individuals who invested in the AT-1 bonds through Yes Bank, 1,311 (97 per cent) were Yes Bank’s own customers. Of these 1,311 customers, 277 prematurely broke their FDs to invest. Going by the amounts of ₹5 lakh to ₹80 lakh that these folks individually invested, wealth managers targeted the bank’s big-ticket depositors to down-sell these bonds.

While you may wonder why a bank’s staff should wean customers away from its own deposit products, this isn’t surprising.

Bank relationship managers in India have a long history of pitching all kinds of risky products to their customers from ULIPs to balanced equity funds to NCDs as fixed deposit substitutes. While they don’t receive any direct commission from such sales, their compensation packages are often linked to how much fee income they generate for the bank from selling exotic products.

So, the next time your bank’s relationship manager sounds as if he or she is doing you a favour by asking you to switch money out of your FD into an exciting new ‘opportunity’, be sceptical.

High returns equal high risk

Investors who are super-careful about avoiding capital losses in equities often turn far less vigilant when it comes to fixed income. The moment a wealth manager or distributor mentions a higher interest rate product, they’re quite eager to switch to make the switch. But the correlation between high returns and capital losses is actually higher with debt instruments than it is with stocks.

In fixed income, if a borrower is willing to offer you a huge rate premium over safe instruments, it is usually a warning sign that they are more likely to delay or default on repayments. Yes Bank’s AT-1 bond investors should have questioned why the same issuer (Yes Bank) should offer its bond investors much higher interest than it does its depositors. The answer quite simply is that AT-1 bonds can skip their interest payouts completely or write off principal, if the bank’s financials are stressed.

An argument that wealth managers used to sell AT-1 bonds to individuals was that they were sound investments, as they were already owned by institutions. This is a poor argument, as risk appetite and return expectation of a retail investor is seldom the same as that of an institutional investor. Institutions that held those bonds probably invested a minuscule portion of their portfolios while HNIs took concentrated exposures.

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Union Bank to issue AT-1 bonds to raise up to ₹1,000 crore

January 7, 2021 root Banking & Finance

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Union Bank of India (UBI), on Thursday, said it will issue Basel III-compliant Perpetual Debt lnstruments, in the nature of Debentures eligible for inclusion in Additional Tier 1 Capital, aggregating up to ₹1,000 crore.

The issue size of the public sector bank’s Basel III-Compliant Additional Tier I Bonds will be ₹300 crore, with a green shoe option of up to ₹700 crore, UBI said in a regulatory filing.

The face value of the bonds, which carry a coupon rate of 8.64 per cent per annum, is ₹1 crore per bond. The pay-in date/ deemed date of allotment of the bonds is January 11, 2021. The bonds will be listed on the NSE.

As per the Term Sheet, the bank can exercise call option with prior approval of the Reserve Bank of India, subject to conditions mentioned in the sheet, on the fifth anniversary from the deemed date of allotment or any allotment anniversary date thereafter

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