Yields on AT1 bonds spike on MFS’ liquidation move

Yields on perpetual bonds issued by banks have shot up in the secondary market as mutual funds (MFS) — the primary investors in these bonds — jostle to sell the papers to avail of liquidity.

Banks had issued these bonds as additional tier 1 (AT1) bonds to raise capital in the past. These bonds have a clause that if the issuer is going through financial constraints, the issuer may choose to not honour the bonds. This is precisely what happened with YES Bank in mid-march when it said AT1 bondholders won’t get their money back.

Now, most of such bonds are held by MFS, and they are in a mad rush to offload these bonds.

However, it is an extremely thin market, and the trade numbers can be as low as just one, but the rise in yields is a reflection of risk-aversion after YES Bank had to spurn its AT1 bond investors. While some bond holders took the legal route to get their dues, the Covid-19-imposed nationwide lockdown and closure of six open-ended debt funds by Franklin Templeton have complicated the matter.

“After the YES Bank AT1 write-down, investors perceive these bonds to be more risky than equities. So the demand is coming in at yields that look more like equity returns,” said Badrish Kulhalli, head of fixed income, HDFC Life Insurance.

Most of these perpetual bonds had yields below 10 per cent before the YES Bank crisis. This signifies that rates have climbed up by 300 basis points or more in less than a month as supply outstripped demand.

The data shows there was one trade of Indusind Bank’s perpetual bond at 16.55 per cent yield. The total value of the bond traded was just ~15 crore.

Another private lender Axis Bank’s perpetual bonds traded at 12 per cent, in two trades aggregating ~65 crore. However, HDFC Bank’s perpetual bonds closed at 9.15 per cent after four trades aggregating ~56 crore, the data from NSE showed.

Public sector banks (PSBS), which are conceived to have government protection, also did not fare well in this environment. Union Bank of India traded at 13 per cent, Canara Bank at 12.2 per cent, Punjab and Sind Bank traded at 14 per cent. Even Bank of Baroda traded at 11.5 per cent, and Punjab National Bank traded at 12.65 per cent. However, State Bank of India’s perpetual bonds traded at 9.26 per cent.

According to bond dealers, this shows that the market participants are just not buying into government guarantee on PSBS, but are discriminating, based on bank’s financials in the books. There is little demand, but high supply. After the closure of Franklin Templeton’s high-yield funds, the redemptions from other credit funds across the industry have picked up. Most of these funds held a reasonable amount of AT1 bonds in their portfolios, said experts.

“In a rush to reduce the below-aaa proportion in their funds as also to raise cash to fund the redemptions, MFS have been selling AT1 bonds,” said Kulhalli.