What Are AT1 Bonds?
AT1 Bonds, also called Additional Tier 1 Bonds, are capital instruments banks issue to raise their core equity base. These bonds are perpetual, meaning they have no maturity date. The investors are not paid back the principal amount. These bonds are primarily issued to acquire long-term capital.
They conformed to the Basel III norms and were introduced by the Basel accord after the global financial crisis to ensure that banks could source their funding during distressful circumstances without reaching out to the government for help.
Table Of Contents
- AT1 bonds are unsecured capital instruments banks issue to raise their core equity base.
- The Basel accord introduced them after the global financial crisis in 2008, and they conform to the Basel III norms.
- These bonds are perpetual, meaning they do not have a maturity period. However, they come with a call option after a minimum of 5 years.
- In a financial crisis, these bonds may refrain from paying interest to bondholders. Additionally, these bonds can be entirely written off without the investor’s consent if the issuing bank’s capital ratio falls below a certain level.
AT1 Bonds Explained
AT1 bonds are issued by banks to augment their core equity base. These bonds have no maturity date and are thus continual. The investors do not get back the bond’s principal amount, nor do they come with a put option where the investors can redeem or sell these bonds to the issuing bank. Although, the AT1 bonds call option allows the issuing bank to redeem these bonds after a specific period.
Investors can neither sell nor redeem these bonds to the issuing bank. However, they come with AT1 bonds call option, whereby the issuing bank can redeem them after a particular period.
A crucial AT1 bonds risk is that in the event of an institutional failure or if the capital ratio of the issuing bank falls below a certain percentage during a particular year, the bank may pay only a part of the interest to the investors or refrain from paying them any interest at all. Furthermore, another AT1 bonds risk is that it comes with the AT1 bonds write-off option. The AT1 bonds write-off allows the issuing bank to write off all the withstanding bonds without soliciting the investor’s permission.
These bonds came into existence after the global financial crisis in 2008. The entire international banking system came together to draw up the Basel accord. AT1 bonds act following the Basel III norms and aim to protect the banking system and depositors during economic distress. These bonds ensure that banks can gather funding during a crisis without relying on the government’s aid.
How To Buy?
The ways to buy AT1 bonds have been discussed below:
- A potential investor can buy individual bonds in the primary market directly from the issuing company. Or they can purchase the bonds from the secondary market; that is, they can buy it from an individual who owns it and is willing to sell it.
- Investors can buy these bonds by investing in bond exchange-traded funds or ETFs. Or they can opt for bond mutual funds. This ensures that the investor will have a diversified portfolio. In addition, they can also avail of the services of a fund manager who will manage the purchase and sales of the securities on the investor’s behalf in exchange for some amount as a fee.
- Another way to buy these bonds is to buy them from brokers. Additionally, several online brokerage sites can help investors buy these bonds.
Let us understand the concept with the following examples:
Suppose the capital ratio of Keepsafe Family Bank fell below 5% due to an economic crisis. Due to its deteriorating financial health, the bank decided to write off its AT1 bonds which amounted to $15 billion. These unsecured bonds jeopardized the investors’ portfolios, leaving them at a loss. The investors ran a protest and even considered legal intervention. However, since these bonds were created with the intent to absorb losses, the investors’ protests remained futile. Therefore, the bonds were written off per the policies of these bonds and the Basel II norms.
Credit Suisse was facing ongoing financial trouble and was set to be taken over by its Swiss rival, UBS. As a part of the acquisition, the FINMA, or the Swiss Financial Market Supervisory Authority, suggested that Credit Suisse’s AT1 bonds will be entirely written off.
The bank, acquired by UBS, has a $17 billion debt, increasing its core equity. This means the amount will only be transferred to the entity and its shareholders. Although the bondholders are considering legal actions, it is being speculated that the Swiss government’s move is only fair as these bonds come with high-risk factors included in their clauses.
AT1 Bonds vs Tier 2 Bonds
- AT1 bonds are perpetual instruments as a result of which they have no maturity date. They are subordinate to Tier 2 bonds. These bonds form the primary fund source of the banks and include the shareholder’s capital and retained earnings.
- Tier 2 bonds are subordinate to unsecured creditors, bank depositors, and senior bonds. They are not perpetual instruments. They have a maturity period of a minimum of 5 years. It also aims to absorb losses, but its inclusion is less strict than AT1 bonds. Tier 2 bonds are used for subordinated term debt, hybrid capital instruments, undisclosed reserves, general loan loss reserves, and revaluation reserves.
Frequently Asked Questions (FAQs)
These bonds are a type of contingent convertible bonds. This means that these bonds yield interest payments, but they can also be exchanged into a certain number of shares of common stock in the issuing bank. The bond’s conversion ratio calculates how many shares the investors will receive. These bonds are hybrid securities with features similar to debts and equity.
These bonds are quite popular owing to their high yields. However, they are mainly known for their increased risk factors. Institutional investors primarily purchase these bonds. Mutual fund owners also invest in these bonds. Investors associated with a high-risk appetite can opt for these bonds. However, they are unsuitable for investors who prefer secure and stable investment options.
Like all other credit instruments, these bonds pay regular interest to the investors. But they do not have a maturity period because they form a part of the issuing bank’s capital, similar to equity. In addition, these bonds come with a call option where the issuing bank can redeem the bonds after a minimum of 5 years. Due to its high-risk nature, the AT1 bonds interest rate is also high, which makes this a high-yielding instrument.
This article has been a guide to what are AT1 Bonds. We explain its in detail with differences with Tier 2 Bonds, how to buy it, and examples. You may also find some useful articles here –