Wealthy investors flock to AT1 bonds amid wave of issuance

By Ashley Coutinho

High net worth investors and institutional investors are flocking to additional Tier I (AT1) bonds in search of higher yields amid a flurry of issuance in recent weeks.

So far in the current financial year, five Public Sector Banks (PSBs) have raised around Rs 15,000 crore through this channel. On Wednesday, the State Bank of India (SBI) raised Rs 6,872 crore through AT1 bonds at a cut-off rate of 7.75%, according to a person briefed. On Tuesday, HDFC Bank issued bonds worth Rs 3,000 crore at 7.84%, while a week earlier Bank of Baroda hit the market with the issuance of around Rs 2,500 crore at 7.84%. 7.88%, according to reports.

Experts said these issues have taken off given the reduction in trading volatility seen in these bonds and cleaner bank balance sheets. These bonds offer a higher yield to investors and an alternative source of capital to issuers.

“Perpetual bonds (AT1 bonds) are very popular among investors in India. Many mutual funds in all categories allocate to AT1 bonds. In fact, wealth managers also recommend perpetual bonds directly to investors,” said Rohit Sarin, co-founder of Client Associates, a wealth management firm.

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AT1 bonds offer relatively higher YTMs than NCDs issued by the same issuer.

For example, an SBI 2026 perpetual bond is available at 7.8% against a AAA-rated non-convertible debenture (NCD) at around 7% and maturing in 2026. These bonds also score higher than fixed deposits, with yields after tax which may be 80%. -90 basis points more for those in the highest tax bracket.

“Wealth managers selectively offer them to clients based on their risk appetite. Customers, on the other hand, prefer high-quality names such as SBI and HDFC Bank,” added A Srikanth, co-founder and CEO of NEO, a multi-family office.

AT-1 bonds, which are perpetual bonds with no maturity date, pay a slightly higher interest rate than similar non-perpetual bonds. Banks have the right but not the obligation to repay the principal amount after exercising a call option.

These bonds had fallen out of favor in early 2020 after the YES Bank episode and rising risk sentiment led individual and institutional investors to dump these bonds. The bank was bailed out by a consortium led by the State Bank of India, which wrote off Rs 8,415 crore of AT-1 bonds under the reconstruction program, resulting in losses for several investors.

“These bonds are unsecured and subordinated. The Bank reserves the right not to pay interest to bondholders if it declares losses during a given year. A call option belongs to the issuer who can call the bonds back on a predefined date if the interest rate drops, which means that these bonds generate little capital appreciation when the interest rate drops,” Sarin said.

Ashish Shanker, managing director and CEO of Motilal Oswal Private Wealth, believes that it is best to stick with bigger and more reliable names such as SBI, HDFC Bank and Axis Bank, as these instruments are unsecured and can be amortized, which makes them risky for individual investors. .

Shanker believes AT1 bonds are more suitable for institutional investors and family offices that have holding company structures that can reduce overall tax expenditures. “People in the highest tax bracket would be better off investing in mutual funds rather than such bonds, given that after-tax returns will be less than 5% after taking into account a rate of ‘full marginal tax of 42.74%,’ he said.

Investors should assess a bank’s balance sheet, ability to raise capital, pedigree, Tier 1 Tier 1 capital and other reserves from which AT-1 bonds will be managed before investing said experts.

CET1 capital is a bank’s Tier 1 capital relative to its total risk-weighted assets.

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