Definition
AT1 Bonds, or Additional Tier 1 Bonds, are a type of unsecured, perpetual bonds that a bank can issue to bolster its core capital base. These bonds have no maturity date, but banks have the option to call back these bonds after a predetermined period. They may offer a higher yield to investors due to their riskier nature, as they are subject to write-offs or conversions into common shares if the bank faces financial stress.
Key Takeaways
- AT1 Bonds, also known as Additional Tier 1 Bonds, are a type of unsecured, perpetual bonds that banks issue to shore up their core capital base to meet Basel-III norms set by RBI in India and globally by the Central Bank in individual countries.
- The issuer of AT1 Bonds has the discretion to skip interest payments if it does not have adequate profits in a particular year. As such, these bonds carry higher risks than traditional bonds and subsequently, offer a higher rate of interest to compensate for that risk factor.
- Unlike typical bonds, AT1 Bonds, due to their perpetual nature, do not have a maturity date. However, the issuer usually has an option to call back or redeem the bonds after a certain period, typically after five years of being issued.
Importance
AT1 Bonds, or Additional Tier 1 Bonds, play a significant role in the financial sector because they are one of the key instruments that banks use to meet their mandatory capital adequacy norms set by regulatory authorities, such as the Basel III norms.
These bonds are considered “perpetual” in nature, meaning they don’t have a fixed maturity, providing banks an endless source of capital.
Additionally, they carry a higher rate of interest compared to traditional bonds, making them attractive to investors seeking higher returns.
However, their risk level is also higher due to certain clauses, including that a bank may forgo paying interest in case of financial distress and, in a worst-case scenario, the principal amount could also be written off.
It’s this balance of reward and risk that makes AT1 Bonds a vital part of the financial ecosystem.
Explanation
AT1 Bonds, also known as Additional Tier 1 Bonds, are unsecured perpetual bonds issued by banks to bolster their core capital base to meet the Basel III regulations developed by the Bank for International Settlements (BIS). The prime purpose of these bonds is to enhance a bank’s capital cushion, in order to make the financial system more resistant and thus to guard against potential financial crises. Banks issue AT1 Bonds to improve their capital ratios and to have a sufficient buffer to absorb any significant losses.
In periods of severe financial stress, these bonds are intended to be either written off or converted into shares. AT1 Bonds play a vital role in capital structure since they are counted as ‘going concern’ capital.
This indicates they aid the bank in absorbing losses while it is still operational, thereby protecting more senior creditors and depositors. Unlike regular bonds, AT1 Bonds offer flexibility to halt coupon payments without being deemed default.
However, they come with a higher risk due to their subordinated status and have discretionary coupons which can be skipped by the issuer. This makes them an important instrument for risk management and an alternative source of funding for banks.
Examples of AT1 Bonds
Banco Santander: In 2020, the Spanish bank Banco Santander was in the news for a controversial decision regarding their AT1 bonds. The bank decided not to call – or buy back – €
5bn of AT1 bonds. This was controversial because traditionally, banks would buy back these bonds at the first possible opportunity.
Deutsche Bank: In 2014, Deutsche Bank issued €
5bn in AT1 bonds as a means of improving their Tier 1 capital ratio, a key measure of a bank’s financial strength. By issuing these bonds, Deutsche Bank was able to bolster its balance sheet and improve investor confidence.
Barclays PLC: In 2013, Barclays sold £2 billion of contingent convertible AT1 bonds. The bond sale was part of a larger effort by the bank to shore up its capital base to meet new regulatory requirements. The bank offering was oversubscribed, indicating a high demand among investors for this type of debt instrument.
FAQs on AT1 Bonds
What are AT1 Bonds?
AT1 or Additional Tier 1 Bonds are a type of unsecured, subordinated debt instruments that a bank issues to raise capital in order to meet their capital adequacy requirements. They are typically perpetual in nature, which means they have no maturity date.
How do AT1 Bonds work?
AT1 bonds pay an interest rate until the bond’s maturity. However, interest payments are not mandatory and can be skipped if the bank’s finances are struggling. They are riskier than traditional bonds and therefore offer a more substantial interest return.
What are the risks associated with AT1 Bonds?
While AT1 Bonds offer high-interest returns, they carry more risks than regular instruments. As they are unsecured, in case of bankruptcy, they will be paid back after other debts. Also, the issuer can skip the interest payments if they aren’t profitable enough. Moreover, they can be written off or converted into equity if the bank’s capital ratio falls below a certain level.
What factors should be considered before investing in AT1 Bonds?
Before investing in AT1 Bonds, one should consider the financial health of the issuing bank, the altogetherness of their bond portfolio, and their risk appetite. It is imperative to evaluate the potential risks and rewards.
Can retail investors buy AT1 Bonds?
Yes, retail investors can buy AT1 Bonds, but it is typically recommended for high-risk-tolerance investors due to the associated risks. They should fully understand the product, its risks, and should consider consulting with a financial advisor before making the investment.
Related Entrepreneurship Terms
- Perpetual Bonds
- Contingent Convertibles (CoCos)
- Capital Adequacy Ratio (CAR)
- Additional Tier 1 Capital
- Credit Risk
Sources for More Information
- Investopedia: A comprehensive well-known information source for investing and finance-related terms and concepts, including AT1 Bonds.
- Reuters: A globally recognized news agency that provides accurate and timely financial information.
- Bloomberg: A leading source for global business and financial information, news and insight.
- The Balance: A source that makes personal finance easy to understand, offers practical solutions, and provides depth and breadth on financial concepts including AT1 bonds.
