Advisors push AT1 bonds to HNIs to take advantage of surge in yields

Yields of perpetual bonds issued by State Bank of India and Bank of Baroda, for instance, have gone up by as much as 80-90 basis points (bps), and top recommendation lists of most managers

Wealth managers are advising their rich clients to buy additional tier 1 (AT1), or perpetual bonds, from the secondary market to take advantage of the surge in yields over the past few days.

Yields of perpetual bonds issued by State Bank of India (SBI) and Bank of Baroda (BoB), for instance, have gone up by as much as 80-90 basis points (bps), and top recommendation lists of most managers.

Yields for HDFC Bank bonds, with a call option in 2022, hardened by 100-120 bps on Wednesday and were trading at 6.75 per cent. Not much trades have been seen in private banks, such as ICICI Bank and Axis Bank, according to market players.

"We typically recommend perpetual bonds of SBI, Bank of Baroda, ICICI Bank, and HDFC Bank as these have a history of sustained profitability. Yields of bonds issued by SBI and BoB have surged 80-90 basis points and it makes sense for wealthy investors to buy them from the secondary market now. The yields may normalise if market regulator Sebi rolls back the diktat to value these bonds as 100-year instruments," said Gaurav Damani, vice president, products and solutions, Sanctum Wealth Management.

At current yields, investors in the highest tax bracket (42.7 per cent) can earn post-tax returns of 4.6-5.07 per cent in the perpetual bonds issued by SBI and BoB, higher than bank fixed deposits and tax-free bonds issued by public sector entities.

"Some asset managers who are concerned about valuations have been selling heavily in the market, which has led to a surge in yields. This has created an opportunity for wealthy investors to buy these bonds from the secondary market as they are available at a discount," said Ajay Manglunia, managing director-fixed income, JM Financial.

According to ICRA’s estimates based on industry data, mutual funds held 30 per cent of tier-I bonds outstanding and 14 per cent of tier-II bonds outstanding in February 2021. With incremental demand from mutual funds for such bonds declining, yields will rise further, making it costlier for banks to raise debt capital.

Manglunia believes that nothing has changed with respect to the underlying risk associated with these bonds and those who understood the ability of the bank to service or exercise the call option can opt for such bonds. The fear that bad loans will surge exponentially in the aftermath of the pandemic has receded, which has added to the comfort of investors.

"Both SBI and BoB are safe bets. SBI is systematically important, while Bank of Baroda is the second-largest PSU bank that has raised equity via the QIP route, as well," said Manglunia.

Public sector banks, such as SBI and BoB, have issued a sizeable quantity of perpetual bonds this year and their float is available in plenty. Private sector banks, such as HDFC Bank, ICICI Bank, and Axis Bank, on the other hand, are adequately capitalised and have chosen to raise equity, instead of hitting the market with perpetual bonds.

According to ICRA’s estimates, total stock of AT1 bonds outstanding was Rs 1.03 trillion as of February 28, 2021, of which 70 per cent was issued by PSBs. Perpetual bonds have no maturity date but come with a call option, which banks can employ to buy the bonds back from investors.

Investors should assess a bank’s balance sheet, its capital raising ability, pedigree and its common equity tier 1 capital, and other reserves from which AT1 bonds will be serviced before investing, said experts. The CET1 capital is a bank’s core equity capital compared with its total risk-weighted assets.