AT-1 bonds just need to be traded often to survive after Sebi rules

*RBI allowed capital-starved banks to raise money through AT-1 bonds or perpetual bonds. *Under the new Sebi rules, mutual funds must treat AT-1 bonds as 100-year paper. The Securities and Exchange Board of India (Sebi) has softened the blow for investors of additional tier-1 (AT-1) bonds by allowing them to value them as 100-year paper in a staggered manner. To begin with, fund managers can consider these bonds as 10-year paper for FY22. Beyond that, it would be a hop of six months and a skip of another six to the 100-year tenure for valuation. In short, fund managers can pretend these bonds have a fixed tenure when actually they don’t, but only for two years. Starting April 2023, the bonds will need to be valued as 100-year papers by investors. AT1 bonds or ‘perps’ (short for perpetual bonds) in market parlance were allowed by the Reserve Bank of India (RBI) to enable capital-starved banks to raise money through a route other than equity. These instruments are essentially debt but with an equity-like characteristic of having perpetual tenure. Banks were also allowed to add a call option at the end of tenth year and then even fifth year to sweeten the bond offerings to investors. That led to a comfort that these bonds can be considered as having a tenure of five-ten years. According to bond traders, most banks have called back these bonds on the scheduled date, giving investors comfort that they do not have to hold it for eternity. To be sure, there have been exceptions such as Yes Bank Ltd, Lakshmi Vilas Bank Ltd and Andhra Bank. But all this confidence shook when the Sebi ordered fund houses to treat these bonds as 100- year paper for valuation purposes. Moreover, a fund house cannot have more than 5% exposure to a single issuer and not more than 10% of the scheme’s net asset value (NAV). While the valuation diktat has been softened, the investment caps still stay. Ergo, incremental demand from mutual funds is expected to thin out. “Banks will have some difficulty in raising money through Tier-1 now because the appetite has reduced. Yields for these bonds have already risen sharply because of the rules," said a bond trader requesting anonymity. That said, there is unlikely to be a huge negative impact on mutual funds, given that these bonds are regularly traded in the market of late. “There are many perpetual bonds that are being traded in the market. Even if on a given day, one bond is traded, it is enough to extrapolate and arrive at a valuation for similar bonds. Of course, some hit on NAV cannot be ruled out," said a debt fund manager, requesting anonymity. Around 12 AT-1 bonds got traded in the market on Tuesday worth roughly ?1000 crore, the reporting platforms of stock exchanges showed.Mutual funds have become wary of perpetual bonds but as long as these bonds are traded regularly, fund houses may not abandon them. Mint, 24th March 2021