The story so far: Depositors and investors in Yes Bank received a rude jolt on March 5 when the Reserve Bank of India (RBI) announced its decision to impose short-term curbs on their withdrawals, citing the bank’s declining financial position. Since then, efforts have been made to quickly stitch together a bailout package for depositors before the event took a systemic toll. With the State Bank of India (SBI) agreeing to acquire a 49% equity stake , other investors joining in and the Cabinet clearing a reconstruction proposal, the fog has cleared a bit for depositors, as the withdrawal limits may soon be lifted. But one set of Yes Bank stakeholders who were expected by the RBI to take immediate and complete write-offs at the first sign of the bank’s troubles, were the holders of its Additional Tier 1 bonds. Apart from mutual funds, pension funds and other institutions who usually invest in such bonds, quite a few retail investors are also stuck with them.
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What are AT1 bonds?
AT1 bonds, also known as Additional Tier 1 bonds, are unsecured perpetual bonds issued by banks to shore up their capital base to meet Basel III requirements. Basel III norms were a set of rules that banking regulators around the world came up with after the global financial crisis in 2008, to strengthen bank balance sheets. Requiring banks to have their own skin in the game in the form of permanent capital, before taking on deposits or loans, is one of the underlying principles of Basel III norms. The RBI’s version of Basel III norms requires Indian banks to hold a minimum capital amounting to 11.5% of their risk-weighted loans. Of this, about 9% is supposed to be the bank’s core capital (called Tier 1), with 5.5% in equity. AT1 bonds are issued by banks to supplement their permanent or Tier 1 capital which is mainly made up of equity shares.
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Don’t bonds have a fixed maturity? Why are AT1 bonds ‘perpetual’? Will investors never get back their principal?
Yes, as per their contract terms, AT1 bonds are supposed to remain permanently with the bank and pay investors interest for perpetuity. In practise though, these bonds have a ‘call option’ after 5 or 10 years that banks use to retire one set of AT1 bonds and issue another. Indian banks have so far never failed to call back their AT1 bonds after 5 or 10 years, and this has led to people forgetting their ‘perpetual’ nature.
In the Yes Bank case, why did the RBI propose that AT1 holders alone must take a write-off?
The contract terms for AT1 bonds mention clearly that the value of these bonds can be completely written off if the bank’s capital ratios fall below certain regulatory thresholds. The write-off also kicks in if the RBI decides that the bank is beyond the “Point of Non Viability” or needs a public sector capital infusion to survive. This is the clause that the RBI seems to have originally invoked in the Yes Bank case. So, even though bond-holders generally come higher in the pecking order of stakeholders than equity shareholders in most situations, AT1 bonds incorporate special situations where their contract terms allow for their holders to suffer write-offs before equity shareholders.
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Are there other such clauses lurking in the fine print for AT1 bonds?
Yes, several. One, these bonds can partly or fully skip their interest payments for any year if the bank’s Tier 1 capital ratios fall below the RBI’s thresholds. They can also give interest payouts a miss if the bank makes losses and has insufficient reserves. Two, the bank can also reduce the principal value of these bonds temporarily or for good, if its equity Tier 1 ratio falls below specified limits. Finally, there is the bombshell clause that the RBI used in Yes Bank. When a bank is teetering, the RBI can decide on a complete write-down of its AT1 bonds or convert them into equity if it feels that it has reached the point of non-viability.
How did these bonds get into the hands of retail investors?
Reports suggest that retail investors were sold these high-value bonds (the face value is ₹10 lakh each) as high-return alternatives to fixed deposits, given that they were offering 2-3% higher interest than FDs. Some investors also bought them through their brokers based on their high yields in the secondary market.
So who should invest in AT1 bonds?
Only affluent investors who are willing to take on higher risk of a capital loss for higher yields.
So what happens to Yes Bank AT1 bond holders?
Bondholders need to wait for clarity from the Centre or Courts. While the RBI’s original scheme had proposed a complete write-off of these bonds, this was protested by institutions who were exploring legal options. The reconstruction scheme notified this week does not mention the way ahead for AT1 bonds.
