Additional Tier 1 bonds - an analysis

An update on AT1 bonds

Additional Tier 1 bonds - an analysis

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• The story: Whent India’s largest public lender State Bank of India (SBI) announced on September 3, 2021 that it raised Rs 4,000 crore through additional Tier 1 (AT1) bonds, many wondered what these were.
• SBI's AT1 bonds: The AT1 bonds were raised by SBI at a coupon rate of 7.72%. It was first such issuance in domestic market after the Securities and Exchange Board of India (SEBI) notified new rules.

1. The SBI has AAA credit rating from local credit agencies while the AT1 offering is rated AA+. This is the highest rating in India for such instruments.
2. The SBI was also the first lender to raise capital through offshore AT1 bonds in 2016. The latest issuance by SBI has encouraged other lenders such as Axis Bank to look after the offshore AT1 bond issue in order to raise about $1 billion.

• Axis Bank AT1 bonds: Axis Bank will use these proceeds for green and social projects. It has set an initial price guidance of 4.4% for the bonds. Axis Bank became the second Indian lender in 2021 to tap overseas debt markets to raise funds using AT1 bonds. HDFC Bank also raised $1 billion, recently.
• AT1 bonds: These bonds are also called "perpetual bonds", and carry no maturity date but have a call option. The issuer of these bonds may call or redeem the bonds in case it is getting money at a cheaper rate, especially when interest rates are decreasing.
• SEBI Rule: SEBI amended the 100-year valuation rule for perpetual bonds, in March 2021. As per new rules, deemed residual maturity period of Basel III AT-1 bonds will be 10 years until March 31, 2022. This period will be increased to 20 and 30 years in subsequent six-month period. According to new rule, from April 2023, residual maturity of AT-1 bonds will become 100 years from the date of issuance of these bonds.

1. Controversy - After the Yes Bank saga of 2020, and the write-off of the AT-1 bonds issued by it, that hugely affected the bondholders and debt mutual funds, SEBI had decided to cap debt mutual fund’s exposure to perpetual bonds (consisting of AT-1 bonds and Tier 2 bonds) to a limit of 10%. This was done in order to protect retail investors participating in debt mutual funds.
2. At that time, fund houses valued perpetual bonds assuming that their issuers will exercise their call options five or ten years from the issue date.
3. But SEBI wanted them to change valuation assuming that the principal will be returned only a 100 years later. Following this tweak in norms, these bonds became ultra long term. Ten days later, SEBI amended the valuation norms on AT-1 bonds after Finance Ministry raised some concerns.

• EXAM QUESTIONS: (1) Explain the controversy of AT1 bonds, in 2020. Why did SEBI change the rules? (2) Why did Yes Bank collapse in 2020? Explain.

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