Saturday, May 18, 2024

AT1 bond jitters needn’t unnerve Indian issuers

As Indian exposure to the snap-up of Credit Suisse by its Swiss rival UBS becomes clearer, chances of its shock-waves reaching our shores seem to have ebbed. The battered bank’s operations in India were too tiny to matter, and while a few of our wealthy might have been on edge before it was rescued, banking circles have been agog with how its $17 billion write-off of Additional Tier 1 bonds shook a global AT1 market placed at about $275 billion. While Credit Suisse’s equity holders only escaped with crumpled holdings, as it got merged with UBS, AT1 debt holders were left with nothing. Pain and perplexity over this, some feared, would doom this asset class. Isn’t debt invariably a prior claimant over equity if a business collapses? Not in this case, as the fine print appears to confirm. Conceived after the West’s 2008 financial crisis to lighten the burden of bailouts, AT1 bonds issued by banks constitute a “contingent convertible” instrument, whereby their value gets converted into equity for a ‘bail in’ or written down if the issuer’s capital drops below a point. To make up for this peculiar risk, holders get higher rates than they would from safer bonds.

Aghast responses to Swiss AT1 losses speak of patchy awareness of such securities being first-hit takers. The event led to a relook at their worth in many parts of the world, even as bond markets broadly signalled they would need to offer bigger returns for takers to be found, especially with confidence in Western bank stability less assured than it was just a few weeks ago. A search for yield had apparently led some investors to pile in when marquee banks looked sound. After scandal-prone Credit Suisse found itself at the losing end of a confidence battle, with its big Saudi backer backing away, the outlook for AT1 bonds took a gloomy turn. Alert Indian bond investors, however, could not have been quite as taken aback. After all, Yes Bank’s insolvency threw up a somewhat similar outcome about three years ago. It was controversial. Although its listed shares were hit hard by a 3-year lock-in which ended some days ago, much of its AT1 debt that got wiped out was held by buyers who claimed they had not been forewarned by sellers. Protests went to court, but a ruling against its AT1 write-off was reportedly stayed by India’s Supreme Court earlier this month.

Arguably, the concept is not in danger. So far in 2022-23, over 33,400 worth of AT1 bonds have been issued by Indian banks at coupon rates ranging from under 8% to well over 9%. Further issues are lined up. While the rates of return demanded by investors could edge up, given the news salience of their extra risk amid a rising-rate scenario, it’s reasonable to expect that most bail-in risk has already been priced in, thanks to the Yes Bank episode. In the final analysis, such bonds not only serve a clearly useful purpose as loss absorbers, they widen the bond market’s array of risk-return choices. They need to exist and will probably survive this week’s global jitters. A longer lasting fallout of recent bank wobbles may be a gradual flight of depositors to banks deemed too big to fail. Technology lets money be moved easily. This would disadvantage smaller lenders. But then, perhaps the sector’s basic model needs to evolve. Why not have the central bank hold all our savings, with commercial banks loaned funds by it to on-lend? It would free lenders to focus on their core job of pricing risk.

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