In my 20 plus years as a fixed income advisor, I’ve seen plenty of investment products come and go. But AT1 bonds remain among the most misunderstood instruments I encounter. Let me share what I’ve learned about these complex securities that continue to attract investors despite their hidden dangers.
What exactly are AT1 bonds?
Additional Tier 1 bonds (AT1 bonds) are perpetual debt instruments issued mainly by banks to strengthen their core capital base. Unlike regular bonds that have a fixed maturity date, these technically never mature. Yes, you read that right—they can exist forever!
I first encountered AT1 bonds back when Indian banks started issuing them more aggressively around 2016. They looked tempting with interest rates sometimes 1-2% higher than regular corporate bonds. Many of my clients were immediately interested, but I always made sure they understood what they were getting into.
Why banks issue these complicated securities
Banks need to maintain certain capital levels as per regulatory requirements like the Basel III norms. AT1 bonds help them meet these requirements without issuing new equity shares.
Think of it this way: when you invest in bonds typically, you’re simply lending money. But with AT1 bonds, you’re almost in a hybrid territory—not quite equity but definitely riskier than traditional debt.
The risks that many investors overlook
The higher returns of AT1 bonds come with significant risks that I’ve seen burn even sophisticated investors:
No maturity date means you’re essentially locking your money indefinitely. Banks have the option to call (repay) the bond after a specified period, usually 5 or 10 years, but they’re not obligated to do so. I had a client who assumed his AT1 bonds would be called after five years only to discover the bank chose not to, leaving his capital indefinitely tied up.
Interest payments can be skipped if the bank faces financial trouble. Unlike regular bonds where missing interest payments would trigger a default, AT1 bonds give banks the right to skip coupon payments without consequences in certain scenarios.
Principal write down risk is perhaps the scariest feature. If a bank’s capital ratios fall below regulatory thresholds, these bonds can be written down partially or completely. This means you could lose your entire investment overnight.
The Yes Bank AT1 bonds fiasco of 2020 showed this risk in action, when bondholders lost everything while equity shareholders still retained some value. I remember consoling several investors who hadn’t fully understood what they’d bought.
Who should consider these investments?
Despite these warnings, AT1 bonds do have a place in certain portfolios. When you invest in bonds of any type, understanding the risk reward tradeoff is crucial.
AT1 bonds might suit you if:
You’re an institutional investor or high net worth individual who can afford to lose the investment
You thoroughly understand banking regulations and can analyze a bank’s financial health
You’re seeking higher yields and can handle the additional risk
You’ve already diversified your fixed income portfolio with safer options
My advice after years in the trenches
I typically advise most retail investors to avoid AT1 bonds altogether. The extra 1-2% yield simply isn’t worth the asymmetric risk. I’ve seen too many retirees attracted by the higher interest rates without grasping the potential downsides.
If you’re determined to explore AT1 bonds, please consider these guidelines:
Invest only a small portion of your overall portfolio (5% maximum is my rule of thumb)
Choose bonds from only the strongest, well capitalized banks
Read the offer document thoroughly, especially clauses about call options and trigger events
Understand that these are not guaranteed by any deposit insurance
Regulations around AT1 bonds continuously evolve, so staying informed is essential. What is true today might change tomorrow as we’ve seen with several regulatory tweaks in recent years.
Remember, higher returns always come with higher risks. In my decades watching financial markets, this principle has never failed.
