Thread by @amiyatosh

Long thread on AT1 Bonds given Yes Bank's collapse. Basel III introduced 3 types of capital:
1. Common Equity Tier 1, CET1
2. Additional Tier 1, AT1 Bonds
3. Additional Tier 2, AT2 Bonds

AT1 is a "contingent" equity capital: it's bond now, equity later if a trigger occurs.

1/n

AT1 is a perpetual bond providing promised coupons if the trigger has not happened. When the bank's equity falls below the trigger one of two things happens: write-off or conversion into common equity as laid out in the contract terms. Bonds are priced to reflect this risk.
2/n

AT1 bond is a "going-concern" capital, i.e., it provides capital before the bank becomes insolvent. AT2 bond is a "gone-concern" capital, i.e., it absorbs losses (for the senior bondholders/depositors) after the insolvency of the bank. AT1 riskier -> attracts higher returns
3/n

AT1's trigger point is set in book value terms, e.g., if CET1 falls below 8%. It is not required, for the conversion/write-off of AT1, that common equity be written off. If the trigger is hit (which indeed happens well-above non-zero CET level), write-off/conversion follows. 4/n

Most (all?) issues are based on book value. Setting triggers on market value creates a circular problem (another way to see why equity need not be wiped out): AT1's value depends on the market value of equity but the market value of equity depends on the value of AT1 bonds. 5/n

Valuation of AT1 complex. We are still learning about this in academia/industry. So it should be handled only by expert hedge funds/ mutual funds. Retail investors should not be allowed to invest in this. Possibility of the misselling way high.
n/n

@andymukherjee70 @dugalira