AT-1 Bonds: Fund houses will request Sebi to reduce the maturity period of AT-1 bonds

Bombay: Mutual Funds plan to ask the Securities and Exchange Board of India to relax maturity norms for additional Tier 1 bonds to encourage fund houses invest in these relatively high-yield debt instruments that banks issue to shore up share capital.

“The Securities and Exchange Board of India (Sebi) has provided some leeway with regard to valuation rules for AT-1 Bonds “But the 100-year maturity requirement for such instruments remains a hurdle for mutual fund investments. Discussions have been held between mutual funds and the regulator and a committee of the Association of Mutual Funds of India (AMFI) will suggest reducing the 100-year maturity to a tenor closer to the call option,” said a source aware of the developments.

An email sent to AMFI seeking comment had not been responded to by press time on Sunday.

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

However, even though the valuation norms were changed, Sebi had said that AT-1 bonds would continue to have a maturity of 100 years. The 100-year maturity requirement for AT-1 bonds was a measure taken to protect retail investors after the Yes Bank The crisis led to huge losses in AT-1 bonds. AT-1 bonds are perpetual bonds that technically have no maturity date. For mutual funds, while the change in the valuation methodology for AT-1 bonds to call provides some respite from volatility in net asset value, the persistence of the 100-year maturity rule means that the scope for AT-1 bonds is limited. investment “Many mutual funds have duration-limited mandates; for example, a short-term duration fund would have a duration limit of 1-1.5 years. This means that even a small investment in an AT-1 bond leads to a very sharp increase in the average maturity and hence the scope to invest in these bonds is limited,” another source said. After the Yes Bank episode, Sebi provided a timeline for mutual funds to value AT-1 bonds as 100-year instruments, starting from April 2023. Prior to this, AT-1 bonds were valued according to the call options on the papers, which were for five or 10 years.

AT-1 bonds have certain stock-like characteristics that allow banks to absorb losses. For investors, the appeal is the high interest rates they offer.

While AT-1 bonds are considered riskier debt instruments due to the provision that allows banks to cancel these securities in case of financial difficulties, the risk perception of these securities is relatively safer when issued by highly rated lenders with strong finances, analysts said.

IMPACT ON BANK FINANCING
The measures taken by Sebi after the cancellation of Yes Bank’s AT-1 bonds led to a sharp fall in mutual fund investments in these instruments as the 100-year valuation and maturity norms implied a constant shift in valuation from call basis to 100-year basis depending on when the instruments were traded in the market.

This led to a marked increase in the volatility of net asset values, which discouraged fund managers from investing in these securities, especially since long-term bonds experience very sharp price swings relative to small movements in their yields.

The investable value of AT-1 bonds of mutual funds stood at ₹2,123 crore as of 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, down 49% from ₹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 fiscal year 25, only one AT-1 bond issue has been made, with Canara Bank In August, banks raised Rs 3,000 crore through such instruments. Over the past two years, banks have faced pressure to mobilise capital and fund strong loan growth amid a slower pace of deposit growth.