AT-1 bonds: Have Indian rating agencies been less prudent than global counterparts?

The Additional Tier-1 bonds (AT-1) issued by banks are inherently risky as they can be written down or converted into equity if the issuer bank runs into trouble. But investors have still flocked to these bonds misled by the relatively higher ratings they carry in India.

Even as YES Bank depositors wait for the cap on withdrawals to be lifted, holders of the bank’s AT-1 bonds have moved quickly to set things right.

As part of its draft restructuring scheme for YES Bank, the RBI decided to write down the bank’s AT-1 bonds in full.

Axis Trustee Services, the debenture trustees for AT-1 bonds issued by the YES Bank to the tune of ₹8,920 crore, has filed a writ petition in the Bombay High Court seeking remedy against the RBI’s move. The petition will be heard on Wednesday.

One of the key arguments put forth by Axis Trustees is that YES Bank’s AT-1 bonds were rated AA by various rating agencies, when they were issued. This indicated a high degree of safety with regard to the timely payment of financial obligations of the issuer bank, relying on which mutual funds, insurance companies, and even retail investors invested in them.

Herein lies the rub.

AT-1 bonds issued by Indian banks have been enjoying higher ratings than those given by global ratings agencies for similar instruments. For instance, AT-1 bonds issued by HDFC Bank, Bank of Baroda, ICICI Bank, State Bank of India, Syndicate Bank, Union Bank carry a rating of AA+ or AA-.

On the other hand, AT-1 bonds issued by global banks such as ABN Amro, American Express, Bank of America, BNP Paribas, Citigroup have been rated BB+, BBB- or BB by Fitch.

AAA is the highest rating and D, indicating default, is the lowest.

YES Bank’s AT-1 bonds that were rated AA to start with when they were issued were downgraded to BBB- in February and finally to D last week.

Relatively higher ratings

A look at the ratings of AT-1 bonds across Indian and global banks, compiled based on Bloomberg data, suggests that there is a three- to five-notch difference between the rating of AT-1 bonds issued by Indian banks and global banks.

AT-1 instruments are risky because aside from writing down their principal value, banks also have the discretion to withhold payment of coupons in times of distress.

While rating AT-1 bonds issued by ABN Amro as BB+, Fitch states that the rating of the bond is notched five times below the bank’s overall viability rating of A, reflecting the loss severity and risk on account of their fully discretionary coupons.

While Indian rating agencies also factor in risks in these bonds, they notch down the rating on AT-1 bonds from the issuing bank’s overall corporate credit rating by only one or two levels in most cases.

With most of AT-1 bonds issued by Indian banks rated AA, the inherent risk in these bonds is often overlooked by investors.