Additional Tier 1 (AT1 Bonds)

Context:

The biggest losers in the Credit Suisse fire sale are investors in the banking major’s riskiest bonds — called Additional Tier 1 or AT1 — who are faced with a $17 billion wipeout, potentially pushing Europe’s $275 billion market for these bonds into turmoil, with likely cascading impact across other geographies.
This is the biggest wipeout yet for Europe’s AT1 market.

About AT1 Bonds:

AT1 bonds, as these instruments are popularly known, are a type of perpetual debt instrument that banks use to augment their core equity base and thus comply with Basel III norms. These bonds were introduced by the Basel accord after the global financial crisis to protect depositors.

These bonds are perpetual in nature — they do not carry any maturity date.
They offer higher returns to investors but compared with other debt products, these instruments carry a higher risk as well.
If the capital ratios of the issuer fall below a certain percentage or in the event of an institutional failure, the rules allow the issuer to stop paying interest or even write down these bonds.
These bonds are subordinate to all other debt and senior only to equity.

AT1 bonds do not have a maturity date. Banks have a call option that permits them to redeem these bonds after a certain period.

Since these bonds can be written down by banks under the directions of the Reserve Bank of India (RBI) in the event of an institutional failure, they are seen as high-risk instruments.
If the bank reaches the point of non-viability, AT1 bonds are the first part of debt that will be written down.
For example, AT1 bonds worth Rs 8,414 crore were written off fully during the Yes Bank reconstruction scheme in March 2020. Those AT1 investors are still locked in a court battle with the RBI and the bank seeking the return of their investments.
In this backdrop, it is fair to say that AT1 bonds are high-risk instruments for investors, especially retail investors.

Banks periodically raise money issuing such bonds.
At one point, lenders used to even pitch these to retail investors as an attractive option, often with returns higher than a traditional fixed deposit would offer.
Indeed, there used to be significant retail interest in AT1 bonds till the Yes Bank episode.
The market for AT1 bonds took a hit after the Yes Bank write-off, as part of the State Bank of India-led bailout in March 2020. Investors have begun to look at these instruments with caution since then.

At nearly $130 trillion, the global bond market far outweighs the stock market in size, and plays an outsize role in the global financial system, especially in the way governments raise funds to manage their deficits.
Rumblings in the bond markets could make it harder for other lenders to raise new AT1 debt, especially when the financial sector is facing tough times.
Following FINMA’s announcement of the CHF 16 billion (about $17.3 billion) write-down of Credit Suisse’s AT1 bonds, European and Asian AT1 bonds tanked on Monday.

The decision to write down Credit Suisse’s AT1 bonds to zero after the lender’s takeover by UBS may contribute to a higher cost of capital for banks, including Indian lenders.
The write-down will weigh on the pricing of such notes and spook investors.
In India, AT1 bonds of Yes Bank were written down in March 2020 after the Reserve Bank of India initiated a restructuring of the troubled lender. Since then, Indian banks have raised AT1 bonds at an up to 75 basis points premium over government bonds.
Some bankers, however, do not see a major impact on the fundraising capabilities of Indian banks through AT1 bonds:
- Spread between regular bonds and AT1 bonds in India is less than 150 basis points, while in the EU and the US, it is 200-250 bps. Indian lenders have limited dependence on such securities. Indian lenders are capable of enduring any potential contagion effects emanating from the US banking turmoil and the Credit Suisse episode given their manageable exposures to global counterparts.
- Strong funding profiles, a high savings rate, and government support are among the factors that bolster the financial institutions and that domestic banks had sufficient buffers to withstand losses on their government securities portfolio due to rising interest rates.