AT1 bonds may give you higher returns, but be mindful of the risks, say experts2 min read . Updated: 05 Oct 2020, 07:04 AM IST
AT1 bonds are hybrid products that offer a fixed return (which can reset), but are as risky as equities
Perpetual or additional tier I (AT1) bonds are making a comeback, as there is a growing demand for bonds of public sector banks (PSBs) and large private banks. They are offering high yields in the current low-interest-rate environment. However, experts speaking at the Mint Money Conversation presented by digibank by DBS highlighted key risks.
“Some of these bonds have a yield-to-maturity (YTM) of 11-11.25%. Investors are looking at bonds of PSBs where the government holds over 80% stakes," said Asheesh Jain, head of investments and forex business, DBS Bank.
AT1 bonds are hybrid products that offer a fixed return (which can reset), but are as risky as equities. These are unsecured instruments, are complex, and investors need to read the fine print before putting money in them.
AT1 bonds are unlike other fixed-income instruments. It is not mandatory for banks to follow what is mentioned in the offer document, like interest payout, when their capital buffers fall short. Risks associated with perpetual bonds came to light when Yes Bank wrote down these bonds as it underwent restructuring. Bondholders saw their investment turn to dust overnight. Last week, the Madras high court ruled against a petition challenging the write-down.
It was known that Yes Bank had problems, and, therefore, risky. But are AT1 bonds of large private banks or the ones backed by the government risky, too?
“Investing in AT1 bonds because a government bank has issued them is not the right approach. Only sophisticated investors should make them a part of their portfolio," said Nitin Singh, MD and global CEO, Avendus Wealth Management.
Banks may specify an interest payout. “However, they can also withhold the annual payment under certain conditions, and if the banks don’t pay, it’s not considered as a default," said Anurag Mittal, fund manager, IDFC Asset Management.
While these bonds are perpetual (no maturity date), they may come with a call date. It means the banks may allow investors to redeem them after some years. “They can choose not to call (redeem) these bonds as they are unable to find better quality capital. Investors must note that they may not be redeemable on the call date," added Mittal.
Investors may need to sell this bond when they want to liquidate their holdings. Fund managers, therefore, prefer bonds that can be easily liquidated. “We use some filters before selecting the bonds. The first filter is the solvency of the issuer, and the second is liquidity. In the case of public banks, solvency may not be an issue. But gauging their liquidity can be tricky," said Saurabh Bhatia, head, fixed income, DSP Investment Managers.
Bhatia prefers entities that pass through the two filters. “Even in worst of times—in March and April—some bonds that passed these two filters were tradable," he said.
Due to the complexities, investors need to take an informed call. A central bank can also direct a bank to cancel its AT1 bonds if it feels that the bank is at risk.
Don’t go by the attractive yields as they don’t give out the real picture. Many times, these bonds are mis-sold, where investors are told that they are like an FD or non-convertible debenture (NCD). Don’t fall for the sales agent’s pitch.