AT-1 Bonds: Fund houses to ask Sebi to cut maturity time for AT-1 bonds

Mumbai: Mutual funds plan to request the Securities and Exchange Board of India to relax maturity norms for additional tier-1 bonds to encourage fund houses to invest in these relatively high-yielding debt instruments that banks issue to shore up equity capital.

“The Securities and Exchange Board of India (Sebi) has provided some leeway when it comes to the valuation norms for AT-1 bonds but the maturity requirement of 100 years for such instruments continues to be a hurdle for mutual fund investments. Talks have been ongoing between mutual funds and the regulator and a committee from the Association of Mutual Funds in India (AMFI) will suggest bringing down the maturity from 100 years to closer to the call option,” a source aware of the developments said.

An email sent to the AMFI seeking comment did not receive a response until Sunday press time.

On August 5, the Sebi said that the valuation of AT-1 bonds my mutual funds would be based on the yield-to-call method, a move that implied lower volatility in net asset value (NAV) emanating from fund houses’ investments in the instrument.

However, while the valuation norms were changed, the Sebi had said that AT-1 bonds would still be of 100-year maturity. The 100-year maturity requirement for AT-1 bonds was a step taken to protect retail investors after the Yes Bank crisis resulted in huge losses on AT-1 bonds. AT-1 bonds are perpetual bonds which technically do not have a maturity date.For mutual funds, while the shift in valuation methodology for AT-1 bonds to the call option provides a reprieve from volatility in the NAV, the persistence of the 100-year maturity norm means that the scope of investment is significantly limited.”A lot of mutual funds have mandates that are limited by duration – for example, a short-term duration fund would have a limit of 1 to 1.5 years. This means that even a small investment in an AT-1 bond leads to a very sharp increase in average maturity and hence the room for investing in these bonds is limited,” another source said.After the Yes Bank episode, the Sebi provided a timeline for mutual funds to value AT-1 bonds as 100-year instruments, starting April 2023. Prior to this, AT-1 bonds were valued according to the call options on the papers, which were five or 10 years.

AT-1 bonds have certain equity-like characteristics and features which permit banks to absorb losses. For investors, the draw is the high rates of interest they offer.

While AT-1 bonds are considered riskier debt instruments because of the provision for banks to write off these securities in the event of financial distress, the risk perception for these securities is relatively safer when issued by highly-rated lenders with strong financials, analysts said.

IMPACT ON BANK FUNDING
The steps taken by the Sebi after the Yes Bank AT-1 bond write-off led to a steep decline in mutual fund investments in the instruments as the 100-year valuation and maturity norms meant a constant switch in valuation from call option basis to 100-year basis depending on when the instruments were traded in the market.

This led to a sharp increase in volatility in NAVs, dissuading fund houses from investing in these papers, especially as long-term bonds witness very sharp swings in prices relative to small movements in yields.

Mutual funds’ investment value AT-1 bonds were at ₹2,123 crore in December 2023, down from ₹25,057 crore in January 2020, three months before Yes Bank collapsed, data provided to ET by CRISIL Market Intelligence and Analytics showed.

Meanwhile, in FY24, banks issued AT-1 bonds worth a total of ₹17,657 crore, 49% lower than ₹34,394 crore in FY23, data provided by debt capital market executives showed. In FY22 banks had issued AT-1 bonds worth ₹29,984 crore.

So far in FY25, only one AT-1 bond issuance has taken place, with Canara Bank raising ₹3,000 crore through such instruments in August. Over the past couple of years, banks have faced pressure to mobilise capital and finance strong loan growth amid a slower pace of deposit growth.