India’s fourth-largest private lender YES bank was placed under a moratorium by RBI and its perpetual debt additional tier-1 (AT1 bonds) would become worthless if RBI does ask mutual funds to write down their value.

What are AT1 bonds?

• AT-1, short for Additional Tier-1 bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet the Basel-III norms.
• AT-1 bonds are complex hybrid instruments, ideally meant for institutions and smart investors who can decipher their terms and assess if their higher rates compensate for their higher risks.
• They carry a face value of ₹10 lakh per bond.
• There are two routes through which retail folk have acquired these bonds — initial private placement offers of AT-1 bonds by banks seeking to raise money; or secondary market buys of already-traded AT-1 bonds based on recommendations from brokers.

Why are they important?

AT-1 bonds have several unusual features lurking in their fine print, which make them very different from plain bonds.

• One, these bonds are perpetual and carry no maturity date. Instead, they carry call options that allow banks to redeem them after five or 10 years. But banks are not obliged to use this call option and can opt to pay only interest on these bonds for eternity.
• Two, banks issuing AT-1 bonds can skip interest payouts for a particular year or even reduce the bonds’ face value without getting into hot water with their investors, provided their capital ratios fall below certain threshold levels. These thresholds are specified in their offer terms.
• Three, if the RBI feels that a bank is tottering on the brink and needs a rescue, it can simply ask the bank to cancel its outstanding AT-1 bonds without consulting its investors. This is what has happened to YES Bank’s AT-1 bond-holders who are said to have invested ₹10,800 crore.

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